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Iraq: 2019 Article IV Consultation and Proposal for Post-program Monitoring—Press Release; Staff Report; And Statement by the Executive Director for Iraq

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
July 2019
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Background: Improved Policy Environment but Medium-Term Risks on the Rise

A. Context

1. Despite its vast oil wealth, Iraq has major development needs and significant institutional weaknesses. It possesses the world’s fourth largest oil reserves, which are projected to last over 100 years at current production rates (Figure 1). Slow progress at channeling these resources into human and physical capital reflects decades of political upheaval and armed conflict as well as the resulting weakness of public institutions; weak governance and corruption are widely acknowledged elements of the problem.1 An exodus of skilled workers amidst poor security conditions since the second gulf war in 2003 has eroded human capital, while the more recent conflict with ISIS led to 100,000 deaths, five million internally displaced people and an estimated $46 billion of damage to infrastructure and property.2 As a result, Iraq’s development needs include large infrastructure gaps, poor basic services, subpar health and education outcomes, and widespread poverty; GDP has barely grown in per capita terms over the past five years.

Figure 1.Iraq: An Oil Dependent Economy, 1980–2018

Sources: OPEC; Rystad Energy; World Bank; U.S. Energy Information Agency; World Economic Outlook; BACI International Trade database; and IMF staff calculations.

Forty Years of Political and Oil Price Shocks

Sources: World Economic Outlook; and IMF staff calculations.

GDP Per Capita

(Index; 2008= 100)

Sources: World Economic Outlook; and IMF staff calculations.

GDP Per Capita

(Index; 2013 = 100)

Sources: World Economic Outlook; and IMF staff calculations.

2. Weak fiscal policy frameworks, which are ill equipped to cope with oil price shocks, have contributed to these outcomes. The authorities have generally saved little during oil price booms, instead ramping up current spending— particularly the civil service payroll and other items that are hard to cut—leaving them with limited buffers when oil prices dipped, and necessitating sharp cuts in investment and the accumulation of arrears. Such procyclical patterns coupled with poor public financial management and inefficient public procurement have hindered investment in infrastructure, especially electricity,3 undermining both core public services and the overall business environment.

Capital Stock

(Index 1980 = 100)

Source: Penn World Tables.

3. The Fund provided a $5.3 billion SBA in 2016 and significant capacity development (see Annex I) to support the authorities’ response to the twin shocks of ISIS and the collapse in oil prices. The main achievements under the SBA were the preservation of the pegged exchange rate, a large fiscal consolidation (albeit mainly through capital expenditure cuts), a reduction in external arrears, and progress on AML/CFT. However, a number of structural fiscal measures were reversed or not enacted, and there has been limited progress at restructuring public banks or strengthening public institutions, while the authorities’ response to Fund advice in the context of the last Article IV has been mixed (see Annex II). The SBA went off track after the second review in August 2017, and expires in July 2019.

4. An improved security situation and the windfall from higher oil prices offer an opportunity to rebuild the country and tackle longstanding social problems. The government faces a wide range of socio-economic challenges, including repairing infrastructure and other property destroyed in the war, as well as improving the provision of electricity, water supply and other public services. A young and fast-growing population is exerting strains on public institutions, while job opportunities for the estimated 800,000 annual entrants to the labor market are limited.

5. The obstacles to progress are formidable. Geopolitical strains are a distraction, with the re-imposition of U.S. sanctions on Iran complicating energy reforms. 4 Weak governance and corruption have impeded public institutions and discouraged private-sector investment and job creation. More positively, relations between Baghdad and the Kurdistan Regional Government (KRG) have improved over the past year.

B. Recent Developments: Slow Post-War Recovery

6. Post-war reconstruction and economic recovery have been slow. The large-scale reconstruction effort that was expected in liberated areas has not yet materialized, with capital spending in these areas totaling just ID 100 billion ($85 million) in 2018, or less than 0.5 percent of the estimated damage. Non-oil GDP rose by only 0.8 percent year-on-year in 2018 on account of weak execution of public investment (including reconstruction) and power outages, while overall GDP contracted by around 0.6 percent as oil production was cut to comply with the OPEC+ agreement. Inflation was flat over the year as a whole (Tables 12).

Table 1.Iraq: Selected Economic and Financial Indicators, 2015–24
Projections
2015201620172018201920202021202220232024
Economic growth and prices
Real GDP (percentage change)2.515.2-2.5-0.64.65.32.62.32.12.1
Non-oil real GDP (percentage change)-14.41.3-0.60.85.45.04.13.42.72.7
GDP deflator (percentage change)-26.1-13.414.615.4-4.52.32.62.83.13.3
GDP per capita (US$)5,0474,8435,2635,8825,7286,0176,1726,3266,4866,666
GDP (in ID trillion)207.2206.7231.0265.0264.8285.4300.4315.9332.3350.4
Non-oil GDP (in ID trillion)137.3138.3140.8145.6158.1173.2188.1202.8217.1232.6
GDP (in US$ billion)177.7175.2195.5224.2224.1241.5254.1267.3281.1296.5
Oil production (mbpd)3.724.634.474.414.594.844.935.015.105.18
Oil exports (mbpd)3.353.793.803.864.034.254.334.404.474.55
Iraq oil export prices (US$ pb) 1/45.935.648.765.256.055.854.954.454.454.8
Consumer price inflation (percentage change; end of period)2.3-1.50.2-0.12.02.02.02.02.02.0
Consumer price inflation (percentage change; average)1.40.50.10.40.82.02.02.02.02.0
National Accounts
Gross domestic investment24.920.816.712.918.816.716.015.615.615.4
Of which: public15.611.58.35.310.68.47.57.06.86.6
Gross domestic consumption81.287.080.879.184.585.486.887.988.689.6
Of which: public22.622.621.821.226.526.326.426.226.226.3
Gross national savings18.412.518.619.813.612.511.711.110.39.4
Of which: public3.1-2.07.013.46.55.24.13.21.80.8
Saving – Investment balance-6.5-8.31.86.9-5.2-4.2-4.3-4.6-5.3-6.0
Public Finance
Government revenue and grants30.626.833.039.840.539.637.936.535.534.6
Government oil revenue27.822.928.936.737.236.334.533.132.031.0
Government non-oil revenue2.84.04.23.13.33.33.43.43.53.5
Expenditure, of which:43.440.734.632.044.643.141.240.540.540.5
Current expenditure27.829.326.426.733.934.733.633.533.733.9
Capital expenditure15.611.58.35.310.68.47.57.06.86.6
Overall fiscal balance (including grants)-12.8-13.9-1.67.9-4.1-3.5-3.3-4.0-5.0-5.9
Non-oil primary fiscal balance, accrual basis (percent of non-oil GDP)-46.5-43.3-39.4-42.4-56.9-52.1-49.2-47.1-46.2-45.3
Adjusted Non-oil primary fiscal balance, accrual basis (excl. KRG, percent of non-oil GDP) 2/-44.7-43.3-39.4-40.5-50.1-46.0-43.6-41.8-41.0-40.2
Adjusted non-oil primary expenditure (excl. KRG, percent of non-oil GDP) 3/48.949.246.346.255.651.549.147.246.345.5
Adjusted non-oil primary expenditure (excl. KRG, annual real growth, percent) 3/-24.70.9-4.52.829.9-0.61.41.63.13.2
Memorandum items
Total government debt (in percent of GDP) 4/56.264.258.949.351.450.550.651.553.656.4
Total government debt (in US$ billion) 4/99.9112.5115.2110.4115.3121.9128.5137.5150.7167.3
External government debt (in percent of GDP)37.237.135.630.632.231.530.528.426.824.9
External government debt (in US$ billion)66.165.069.568.772.276.277.675.875.373.8
Monetary indicators
Growth in reserve money-12.09.2-4.46.72.55.44.74.95.14.6
Growth in broad money-9.17.12.62.72.56.25.46.05.95.3
External sector
Current account-6.5-8.31.86.9-5.2-4.2-4.3-4.6-5.3-6.0
Trade balance-0.1-1.77.613.43.54.13.22.01.30.5
Exports of goods31.828.634.841.237.036.234.433.132.031.2
Imports of goods-31.9-30.3-27.1-27.8-33.5-32.0-31.2-31.1-30.8-30.7
Overall external balance-6.7-3.72.56.3-2.5-1.1-1.6-3.5-3.8-4.7
Gross reserves (in US$ billion)54.145.549.464.757.253.548.538.828.214.3
Total GIR (in months of imports of goods and services)9.37.87.38.06.86.25.54.22.91.4
Exchange rate (dinar per US$; period average)1,1661,1801,1821,1821,1821,1821,1821,1821,1821,182
Real effective exchange rate (percent change, end of period) 5/6.51.8-5.14.9
Sources: Iraqi authorities; and Fund staff estimates and projections.

Negative price differential of about $3.6 per barrel compared to the average petroleum spot price (average of Brent, West Texas and Dubai oil prices) in 2018–23.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude full year estimate of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Includes arrears. The debt stock includes legacy arrears to non-Paris Club creditors on which th e authorities have requested (but not yet obtained) Paris-Club comparable relief. Implementing comparable terms will substantially reduce debt (e.g. by 15 percent of GDP in 2017).

Positive means appreciation.

Sources: Iraqi authorities; and Fund staff estimates and projections.

Negative price differential of about $3.6 per barrel compared to the average petroleum spot price (average of Brent, West Texas and Dubai oil prices) in 2018–23.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude full year estimate of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Includes arrears. The debt stock includes legacy arrears to non-Paris Club creditors on which th e authorities have requested (but not yet obtained) Paris-Club comparable relief. Implementing comparable terms will substantially reduce debt (e.g. by 15 percent of GDP in 2017).

Positive means appreciation.

Table 2.Iraq: Central Government Fiscal Accounts, 2015–24(In trillions of Iraqi dinars, unless otherwise indicated)
Projections
2015201620172018201920202021202220232024
Revenues and grants63.555.576.3105.6107.3113.1113.9115.3117.9121.1
Revenues63.555.576.3105.6107.3113.1113.9115.3117.9121.1
Oil57.747.266.797.398.5103.6103.7104.4106.3108.7
Crude oil export revenues57.246.665.296.197.3102.4102.5103.2105.1107.5
Transfers from oil-related public enterprises0.50.40.30.40.40.40.40.40.40.4
Tax on oil company profits0.00.31.20.80.70.80.80.80.80.8
Non-oil5.88.39.68.38.89.510.210.911.612.4
Tax revenues1.45.26.74.95.25.55.86.26.67.0
Direct taxes1.13.73.92.62.52.72.93.13.33.5
Indirect taxes0.41.52.92.32.72.83.03.13.33.5
Non-tax revenues4.43.02.93.43.74.04.34.75.05.3
Grants0.00.00.00.00.00.00.00.00.00.0
Expenditures90.084.280.184.7118.0123.1123.7128.0134.6141.8
Current expenditures57.660.560.970.789.999.0101.0105.9111.9118.8
Salary and pension42.241.642.948.357.861.664.667.570.974.7
Salary33.132.333.437.746.049.752.455.158.261.7
Pension9.09.39.510.611.712.012.212.512.713.0
Goods and services4.75.07.58.012.413.514.615.316.317.4
Transfers9.512.58.210.215.215.916.717.518.319.2
Interest payments1.31.42.33.73.04.95.15.66.47.5
War reparations 1/0.00.00.00.41.53.10.00.00.00.0
Investment expenditures32.423.719.214.028.124.122.622.222.723.0
Non-oil investment expenditures13.39.06.53.613.48.66.96.16.46.4
Oil investment expenditures19.114.712.610.514.715.515.816.016.316.6
Fiscal balance-26.6-28.7-3.720.9-10.7-10.0-9.8-12.7-16.7-20.7
Statistical discrepancy0.0-0.30.20.0
Financing26.629.03.5-20.910.710.09.812.716.720.7
External financing4.22.44.01.23.04.71.6-2.4-0.5-1.9
Budget Loans2.83.54.00.30.00.00.00.00.00.0
International Financial Institutions2.83.21.10.00.00.00.00.00.00.0
Bilateral0.00.30.60.30.00.00.00.00.00.0
Eurobond0.00.02.40.00.00.00.00.00.00.0
Project Loans0.32.32.21.16.05.53.82.21.00.6
Donor funds for reconstruction0.00.00.00.01.23.94.34.75.95.9
Amortization-1.6-1.1-1.0-1.7-2.8-4.9-6.5-9.3-7.5-8.5
Assets held abroad0.00.00.00.00.00.00.00.00.00.0
SDR Holding2.20.00.00.00.00.00.00.00.00.0
Account payables-4.8-0.30.60.00.00.20.10.10.10.1
Arrears5.3-2.0-1.91.5-1.30.00.00.00.00.0
Domestic financing22.326.7-0.5-22.17.85.38.215.117.222.6
Bank financing24.021.90.3-21.68.95.38.215.117.222.6
CBI10.116.71.2-19.18.94.35.911.412.516.4
Loans6.414.32.4-1.51.32.33.99.411.515.4
Deposits3.72.4-1.2-17.67.62.02.02.01.01.0
Commercial banks13.95.2-0.8-2.50.01.02.33.74.76.2
Loans7.90.60.0-2.50.01.02.33.74.76.2
Deposits6.04.6-0.80.00.00.00.00.00.00.0
Non-bank financing0.02.01.51.20.20.00.00.00.00.0
Net sale of government financial assets0.80.30.30.00.00.00.00.00.00.0
Account payables-0.11.80.30.00.00.00.00.00.00.0
Arrears3.70.7-3.0-1.7-1.30.00.00.00.00.0
Financing gap 2/0.00.00.00.00.00.00.00.00.00.0
Memorandum items
Non-oil primary expenditure, accrual basis69.768.165.170.198.999.7102.8106.4111.9117.7
Adjusted non-oil primary expenditure, accrual basis (excluding KRG) 3/67.168.165.167.288.089.292.295.6100.5105.8
Adjusted non-oil primary expenditure, accrual (annual real growth, percent) 3/-24.70.9-4.52.829.9-0.61.41.63.13.2
Domestic inflation (in percent)1.40.50.10.40.82.02.02.02.02.0
Non-oil primary fiscal balance, accrual basis-63.9-59.9-55.5-61.8-90.0-90.2-92.6-95.6-100.3-105.4
Adjusted non-oil primary fiscal balance, accrual basis (excluding KRG) 4/-61.3-59.9-55.5-58.9-79.2-79.7-82.1-84.8-88.9-93.5
Non-oil primary fiscal balance, cash basis 5/-59.3-58.7-59.7-63.7-92.7-90.2-92.6-95.6-100.3-105.4
Adjusted non-oil primary fiscal balance, cash basis (excluding KRG) 4,5/-56.8-58.7-59.7-60.8-81.8-79.7-82.1-84.8-88.9-93.5
Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

7. The fiscal and external positions improved significantly in 2018 due to the rebound in oil prices and underexecution of the capital budget (Tables 35).

  • A large fiscal surplus—around 8 percent of GDP—was recorded in 2018 due to larger than expected oil revenues and a significant underexecution of the capital budget. However, the underlying fiscal position barely improved as non-oil revenue collection declined significantly (due to weak compliance) and current spending expanded by 5 percentage points of non-oil GDP.
  • The government retired some domestic debt, including unwinding ID 1 trillion (about$0.9 billion) of indirect monetary financing, and accumulated fiscal buffers (about $17 billion). Public debt fell to 49 percent of GDP at end-2018 (Table 1).
  • Higher oil prices and the modest improvement in the underlying fiscal position also led to a large current account surplus in 2018 (5¾ percent of GDP). Gross international reserves reached $65 billion by end-December, outstripping standard reserve adequacy metrics.
  • The spread between official and market FX rates has narrowed to below 2 percent in recent months, from 6.25 percent at end-2017, as the comfortable reserve position has allowed the CBI to satisfy banks’ FX demand.
Table 3.Iraq: Central Government Fiscal Accounts, 2015–24(In percent of GDP)
Projections
2015201620172018201920202021202220232024
Revenues and grants30.626.833.039.840.539.637.936.535.534.6
Revenues30.626.833.039.840.539.637.936.535.534.6
Oil27.822.928.936.737.236.334.533.132.031.0
Crude oil export revenues27.622.528.236.236.835.934.132.731.630.7
Transfers from oil-related public enterprises0.20.20.10.20.10.10.10.10.10.1
Tax on oil company profits0.00.10.50.30.30.30.30.20.20.2
Non-oil2.84.04.23.13.33.33.43.43.53.5
Tax revenues0.72.52.91.82.01.91.92.02.02.0
Direct taxes0.51.81.71.00.90.91.01.01.01.0
Indirect taxes0.20.71.20.91.01.01.01.01.01.0
Non-tax revenues2.11.51.31.31.41.41.41.51.51.5
Grants0.00.00.00.00.00.00.00.00.00.0
Expenditures43.440.734.632.044.643.141.240.540.540.5
Current expenditures27.829.326.426.733.934.733.633.533.733.9
Salary and pension20.420.118.618.221.821.621.521.421.321.3
Salary16.015.614.514.217.417.417.517.417.517.6
Pension4.44.54.14.04.44.24.13.93.83.7
Goods and services2.32.43.33.04.74.74.84.84.95.0
Transfers4.66.03.53.85.85.65.65.55.55.5
Interest payments0.60.71.01.41.11.71.71.81.92.1
War reparations 1/0.00.00.00.20.61.10.00.00.00.0
Investment expenditures15.611.58.35.310.68.47.57.06.86.6
Non-oil investment expenditures6.44.32.81.45.13.02.31.91.91.8
Oil investment expenditures9.27.15.53.95.55.45.25.14.94.7
Fiscal balance-12.8-13.9-1.67.9-4.1-3.5-3.3-4.0-5.0-5.9
Statistical discrepancy0.0-0.10.10.0
Financing12.814.01.5-7.94.13.53.34.05.05.9
External financing2.01.11.80.41.11.60.5-0.7-0.2-0.6
Budget Loans1.41.71.80.10.00.00.00.00.00.0
International Financial Institutions1.41.60.50.00.00.00.00.00.00.0
Bilateral0.00.10.30.10.00.00.00.00.00.0
Eurobond0.00.01.00.00.00.00.00.00.00.0
Project Loans0.11.11.00.42.31.91.20.70.30.2
Donor funds for reconstruction0.00.00.00.00.41.41.41.51.81.7
Amortization-0.8-0.5-0.4-0.6-1.1-1.7-2.2-3.0-2.3-2.4
Assets held abroad0.00.00.00.00.00.00.00.00.00.0
SDR Holding1.00.00.00.00.00.00.00.00.00.0
Account payables-2.3-0.20.30.00.00.10.00.00.00.0
Arrears2.5-1.0-0.80.6-0.50.00.00.00.00.0
Domestic financing10.812.9-0.2-8.32.91.92.74.85.26.5
Bank financing11.610.60.1-8.13.41.92.74.85.26.5
CBI4.98.10.5-7.23.41.52.03.63.84.7
Loans3.16.91.0-0.60.50.81.33.03.54.4
Deposits1.81.2-0.5-6.62.90.70.70.60.30.3
Commercial banks6.72.5-0.4-1.00.00.40.81.21.41.8
Loans3.80.30.0-1.00.00.40.81.21.41.8
Deposits2.92.2-0.40.00.00.00.00.00.00.0
Non-bank financing0.01.00.70.40.10.00.00.00.00.0
Net sale of government financial assets0.40.10.10.00.00.00.00.00.00.0
Account payables-0.10.80.10.00.00.00.00.00.00.0
Arrears1.80.3-1.3-0.6-0.50.00.00.00.00.0
Financing gap 2/0.00.00.00.00.00.00.00.00.00.0
GDP to compute ratios207.2206.7231.0265.0264.8285.4300.4315.9332.3350.4
Memorandum items
Non-oil primary expenditure, accrual basis (percent of GDP)33.633.028.226.437.334.934.233.733.733.6
Adjusted non-oil primary expenditure, accrual basis (excl. KRG, percent of GDP) 3/32.433.028.225.433.231.330.730.330.330.2
Non-oil primary fiscal balance, accrual basis (percent of GDP)-30.8-29.0-24.0-23.3-34.0-31.6-30.8-30.3-30.2-30.1
Adjusted non-oil primary fiscal balance, accrual basis (excl. KRG, percent of GDP) 4/-29.6-29.0-24.0-22.2-29.9-27.9-27.3-26.8-26.8-26.7
Non-oil primary fiscal balance, cash basis (percent of GDP) 5/-28.6-28.4-25.8-24.0-35.0-31.6-30.8-30.3-30.2-30.1
Adjusted Non-oil primary fiscal balance, cash basis (excluding KRG, percent of GDP) 4,5/-27.4-28.4-25.8-22.9-30.9-27.9-27.3-26.8-26.8-26.7
Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

Table 4.Iraq: Central Government Fiscal Accounts, 2015–24(In percent of non-oil GDP)
Projections
2015201620172018201920202021202220232024
Revenues and grants46.240.154.272.567.965.360.656.954.352.1
Revenues46.240.154.272.567.965.360.656.954.352.1
Oil42.034.247.466.862.359.855.151.548.946.7
Crude oil export revenues41.633.746.366.061.559.254.550.948.446.2
Transfers from oil-related public enterprises0.30.30.20.30.30.20.20.20.20.2
Tax on oil company profits0.00.20.80.60.50.40.40.40.40.3
Non-oil4.26.06.85.75.65.55.45.45.35.3
Tax revenues1.13.84.83.33.33.23.13.13.03.0
Direct taxes0.82.72.71.81.61.51.51.51.51.5
Indirect taxes0.31.12.01.61.71.61.61.51.51.5
Non-tax revenues3.22.22.12.42.32.32.32.32.32.3
Grants0.00.00.00.00.00.00.00.00.00.0
Expenditures65.560.956.958.274.671.165.863.162.061.0
Current expenditures42.043.843.348.556.857.253.752.251.551.1
Salary and pension30.730.130.533.236.535.634.433.332.632.1
Salary24.123.423.825.929.128.727.927.226.826.5
Pension6.66.76.87.27.46.96.56.15.95.6
Goods and services3.43.65.35.57.97.87.77.67.57.5
Transfers6.99.05.87.09.69.28.98.68.48.3
Interest payments1.01.01.62.61.92.82.72.72.93.2
War reparations 1/0.00.00.00.30.91.80.00.00.00.0
Investment expenditures23.617.113.69.617.813.912.010.910.49.9
Non-oil investment expenditures9.76.54.62.58.55.03.73.02.92.8
Oil investment expenditures13.910.69.07.29.39.08.47.97.57.1
Fiscal balance-19.3-20.8-2.714.4-6.8-5.8-5.2-6.3-7.7-8.9
Statistical discrepancy0.0-0.20.10.0
Financing19.321.02.5-14.46.85.85.26.37.78.9
External financing3.11.72.90.81.92.70.8-1.2-0.2-0.8
Budget Loans2.12.52.90.20.00.00.00.00.00.0
International Financial Institutions2.12.30.80.00.00.00.00.00.00.0
Bilateral0.00.20.40.20.00.00.00.00.00.0
Eurobond0.00.01.70.00.00.00.00.00.00.0
Project Loans0.21.71.60.73.83.22.01.10.50.3
Donor funds for reconstruction0.00.00.00.00.72.32.32.32.72.5
Amortization-1.1-0.8-0.7-1.2-1.8-2.9-3.5-4.6-3.5-3.7
Assets held abroad0.00.00.00.00.00.00.00.00.00.0
SDR Holding1.60.00.00.00.00.00.00.00.00.0
Account payables-3.5-0.20.40.00.00.10.00.00.00.0
Arrears3.8-1.5-1.31.0-0.80.00.00.00.00.0
Domestic financing16.319.3-0.4-15.24.93.14.47.47.99.7
Bank financing17.515.80.2-14.85.63.14.47.47.99.7
CBI7.312.10.8-13.15.62.53.15.65.87.1
Loans4.610.31.7-1.00.81.32.14.65.36.6
Deposits2.71.8-0.8-12.14.81.21.11.00.50.4
Commercial banks10.23.7-0.6-1.70.00.61.21.82.22.7
Loans5.80.40.0-1.70.00.61.21.82.22.7
Deposits4.43.3-0.60.00.00.00.00.00.00.0
Non-bank financing0.01.51.10.80.10.00.00.00.00.0
Net sale of government financial assets0.60.20.20.00.00.00.00.00.00.0
Account payables-0.11.30.20.00.00.00.00.00.00.0
Arrears2.70.5-2.1-1.2-0.80.00.00.00.00.0
Financing gap 2/0.00.00.00.00.00.00.00.00.00.0
Memorandum items
Non-oil primary expenditure, accrual basis (percent of non-oil GDP)50.749.246.348.162.557.554.752.551.550.6
Adjusted non-oil primary expenditure, accrual basis (excl. KRG, percent of non-oil GDP) 3/48.949.246.346.255.651.549.147.246.345.5
Non-oil primary fiscal balance, accrual basis (percent of non-oil GDP)-46.5-43.3-39.4-42.4-56.9-52.1-49.2-47.1-46.2-45.3
Adjusted non-oil primary fiscal balance, accrual basis (excl. KRG, percent of non-oil GDP) 4/-44.7-43.3-39.4-40.5-50.1-46.0-43.6-41.8-41.0-40.2
Non-oil primary fiscal balance, cash basis (percent of non-oil GDP) 5-43.2-42.4-42.4-43.7-58.6-52.1-49.2-47.1-46.2-45.3
Adjusted Non-oil primary fiscal balance, cash basis (excl. KRG, percent of non-oil GDP) 4,5/-41.3-42.4-42.4-41.8-51.7-46.0-43.6-41.8-41.0-40.2
Non-oil GDP (ID trillion)137.3138.3140.8145.6158.1173.2188.1202.8217.1232.6
Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

Sources: Iraqi authorities; and Fund staff estimates and projections.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.

Table 5.Iraq: Balance of Payments, 2015–24(In billions of U.S. dollars, unless otherwise indicated)
Projections
2015201620172018201920202021202220232024
Trade balance-0.2-314.930.17.8108.15.43.61.5
On percent of GDP]-0.1-1.77.613.43.54.13.221.30.5
Exports56.5506892.482.987.387.588.490.192.4
Crude oil56.149.767.691.982.386.786.787.488.990.9
Other exports0.40.40.40.50.60.60.811.21.5
Imports-56.7-53.1-53.1-62.3-75.1-77.3-79.4-83-86.5-90.9
Private sector imports-41.6-38.3-38.7-4146.847.6-48.7-50.6-53.4-56.1
Government imports-15.1-14.8-14.4-21.3-28.3-29.7-30.7-32.4-33.1-34.8
Services, net-10.7-10.7-10.2-12.1-15.1-15-15.2-14.9-15.3-16.2
Receipts6.36.26.56.378.28.38.899.2
Payments-16.9-16.9-16.7-18.4-22.1-23.2-23.6-23.8-24.3-25.4
Income, net-1.3-1.3-2.2-2.9-2.3-2.6-2.9-3-3.2-3.4
Transfers, net0.50.610.3-2-2.6-0.80.400.4
Private, net0.40.40.40.40.40.40.40.40.40.4
Official net0.10.20.6-0.1-2.4-3-1.30-0.40
Current account-11.6-14.53.615.5-11.6-10.2-10.8-12.2-14.8-17.7
On percent of GDP]-6.5-8.31.86.9-5.2-4.2-4.3-4.6-5.3-6
Capital account0000000000
Financial account8.39.27.1-15.97.66.72.84.13.8
Direct and portfolio investment (net]2.81.81.8111.42.52.52.52.5
Other capital, net5.57.45.4-24.96.24.20.31.61.3
Official net-4.54.15.50.95.652.3-1.7-0.5-1.7
Assets-6.1000000000
Liabilities1.64.15.50.95.652.3-1.7-0.5-1.7
Disbursements12.74.96.72.27.386.85.85.95.5
Amortization-1.1-0.9-1.2-1.3-1.7-3-4.6-7.6-6.4-7.2
Private, net103.4-0.2-2.9-0.71.2222.13
Errors and omissions-8.7-1.3-5.8-0.2000000
Overall balance-12-6.6514.2-5.7-2.6-4.1-9.4-10.7-13.9
On percent of GDP]-6.7-3.72.56.3-2.5-1.1-1.6-3.5-3.84.7
Financing126.6-5-14.25.72.64.19.410.713.9
Development Fund for Iraq (increase -] 2/-1.70.6-10000000
Gross International Reserves (increase -]13.98-2.9-15.37.53.759.710.613.9
Fund credit (repayment]-0.6-0.10-0.2-0.7-1.2-1-0.300
Change in arrears (negative = decrease]4.5-1.7-1.61.3-1.100000
Change in payables (negative = decrease]-4.1-0.30.5000.10000
Financing gap (increase -] 3/0000000000
Memorandum items
GIR (end of period]54.145.549.464.757.253.548.538.828.214.3
Total GIR (in months of imports of goods and services]9.37.87.386.86.25.54.22.91.4
GDP177.7175.2195.5224.2224.1241.5254.1267.3281.1296.5
Of which Non-oil GDP117.8117.2119.1123.2133.8146.5159.1171.6183.7196.8
Sources; Iraqi authorities; and Fund staff estimates and projections.

Includes prospective disbursements from the IMF, WB and other donors in 2016–19.

Reflects the transfer of the Development Fund for Iraq from the Federal Reserve Bank of New York to the CEI in May 2014.

Includes unidentified financing only.

Sources; Iraqi authorities; and Fund staff estimates and projections.

Includes prospective disbursements from the IMF, WB and other donors in 2016–19.

Reflects the transfer of the Development Fund for Iraq from the Federal Reserve Bank of New York to the CEI in May 2014.

Includes unidentified financing only.

8. Iraq’s external position in 2018 was substantially stronger than suggested by desirable policies and fundamentals (see Annex III). The sizable surplus realized in 2018 was 10 percent of GDP higher than staff’s current account norm of a 4½ percent of GDP deficit, developed from a model tailored to resource-rich countries such as Iraq with large investment needs. The real effective exchange rate (REER) appreciated by 4.9 percent year on year in 2018, continuing a gradual trend since 2013 due mostly to movements in the nominal effective exchange rate (NEER).

9. Bank balance sheets remain weak, and private-sector credit is growing but from a very low base. Two large public banks—Rafidain and Rasheed (R&R)—are burdened by legacy assets as well as loans to SOEs, while NPLs are high at a number of private banks. R&R’s capital is below statutory levels, while private banks are losing money due to the compression of spreads in the FX market, and could face capital constraints. The private-sector credit stock was only 9 percent of GDP at end-2018, up 9 percent year on year.

10. Parliament adopted a new General Financial Management Law (GFML) in May 2019 that strengthens the legal framework for public financial management.5 The law defines general government for the first time, establishes the need for a medium-term fiscal framework and enshrines fiscal transparency requirements. It also limits parliament’s capacity to amend the budget, as well as the scope for spending to be authorized outside budget processes. A number of gaps remain, including regarding guarantees and a treasury single account, that will need to be addressed by secondary legislation and/or decisions by the council of ministers. Newly introduced elements of fiscal federalism could erode non-oil revenue.

C. Outlook and Risks: Vulnerabilities on the Rise Again

11. The 2019 budget implies a large fiscal loosening that will reverse the recent reduction in vulnerabilities. Current spending is projected to rise by 27 percent year on year in the budget due to large increases in the public-sector wage bill, transfers, good and services, as well as allocations to KRG. Staff baseline projections assume that the wage bill will exceed budget provisions, due to weak PFM controls, and total more than 17 percent of GDP—the equivalent of 47 percent of oil revenues—whereas the budgeted ramp-up in capital spending will likely not fully materialize due to absorption constraints. The abolition of non-oil taxes will dampen revenues. As a result, the budget is projected to shift from a surplus of close to 8 percent in 2018 to a deficit of 4 percent of GDP in 2019, and reserves are projected to decline in 2019.

12. In the absence of policy changes, the fiscal position will deteriorate over the medium term as oil prices subside and current expenditure persists at an elevated level (Tables 19). Sizable fiscal and external deficits will be recorded—both reaching around 6 percent of GDP by 2024—with reserves falling steadily to well below adequate levels and fiscal buffers eroded. Public debt will increase but remains sustainable, although financing needs will increase and remain above the high-risk threshold (see Annex IV). The government will likely need to rely on financing that crowds out the private sector or depletes reserves, and will be unable to fulfill more than a quarter of reconstruction needs over the medium term.

Table 6.Iraq: Monetary Survey, 2015–24(In billions of Iraq dinars, unless otherwise indicated)
Projections
2015201620172018201920202021202220232024
Net foreign assets75,16360,60063,89236,26675,27672,37067,57056,43643,93027,540
Of which: CBI60,72549,55052,86471,21263,26760,35255,54344,45131,33615,488
Net domestic assets9,20329,72623,3138,97722,34631,32441,76259,33678,751101,686
Domestic claims17,32236,44439,01816,42827,24634,82445,46262,33682,451107,536
Net claims on general government-8,11911,12513,173-6,6622,2217,52215,73530,33343,03670,652
Claims on general government23,62741,49044,38544,35345,63648,93755,15068,25384,451106,066
less: Liabilities to general government-36,746-30,365-31,212-51,015-43,415-41,415-39,415-37,415-36,415-35,415
Claims on other sectors25,44125,31825,34423,09025,02427,30229,72732,04734,41436,334
Other Item Net (OIN)-8,114-6,718-10,199-7,451-4,900-3,500-3,700-3,500-3,700-5,850
Broad money84,37090,32692,71095,24397,622103,695109,332115,872122,630129,226
Currency outside banks34,85542,07540,34340,49841,65344,07346,29048,73351,40353,945
Transferable deposits34,75833,44936,64337,33138,16540,65642,93345,78343,60451,334
Other deposits14,75714.30215,72417,41417,80313,96620,05321,35722,67323,946
Memorandum items
Broad money (percentage growth)-9.17.12.62.72.56.25.46.05.95.3
Broad money (in percent of GDP)40.743.740.141.236.936.336.436.736.936.9
M2 velocity (based on non-oil GDP)1.61.51.51.51.61.71.71.31.31.3
Credit to the economy (percentage growth)4.3-0.52.1-10.73.49.13.97.37.47.2
Credit to the economy (in percent of GDP)12.312.211.23.79.49.69.910.110.410.5
Credit to the private sector (percentage growth)5.93.26.79.0349.13.97.87.47.2
Credit to the private sector (in percent of GDP)9.39.69.28.79.39.29.39.39.49.5
Sources: Iraqi authorities; and Fund staff estimates and projections.
Sources: Iraqi authorities; and Fund staff estimates and projections.
Table 7.Iraq: Central Bank Balance Sheet, 2015–24(In billions of Iraqi dinars, unless otherwise indicated)
Projections
2015201620172018201920202021202220232024
Net foreign assets60,72549,55052,86471,21263,26760,35255,54344,45131,88615,488
Foreign assets64,28554,21958,86276,96668,08263,73357,76946,30833,74317,344
Official reserve assets63,83053,77458,38976,50267,61863,26957,30545,84433,27916,880
Gold3,6263,9574,4334,6895,0645,4695,9076,3796,8907,441
Other59,80949,14953,46071,32862,06957,31550,91438,98025,9058,955
SDR holdings and reserve position in the Fund395482497484484484484484484484
Other foreign assets455446472464464464464464464464
Foreign liabilities-3,416-4,669-5,939-5,645-4,815-3,381-2,226-1,856-1,857-1,856
Net domestic assets5,19419,16614,664-1,1808,54915,37423,72138,71055,53475,945
Domestic assets3,06216,91014,367-947,95910,82615,58426,61839,11655,531
Net claims on general government3,04016,28112,909-1,8636,1919,05713,81524,84937,34753,762
Loans to central government2,4662,4662,2712,0161,186-249-1,404-1,773-1,773-1,773
Holdings of discounted treasury bills6,32917,77117,74116,39417,67719,97823,89133,29444,79260,208
Domestic currency deposits-1,523-455-2,478-5,315-3,035-2,435-1,835-1,235-935-635
Foreign currency deposits-4,232-3,500-4,625-14,957-9,637-8,237-6,837-5,437-4,737-4,037
Monetary policy instruments 1/-1,120-3,199-1,500-1,0526234,5828,17112,12616,45220,448
Other items net3,2605,4552,831-34-34-34-34-34-34-34
Reserve money62,91468,71665,69070,06671,81575,72679,26483,16187,42091,433
Currency in circulation38,58545,23244,23747,16948,16150,52552,62454,91557,45959,825
Bank reserves24,32923,48521,45322,89623,65425,20126,64028,24729,96131,607
Other liquid liabilities0000
Memorandum items
Reserve money (annual growth, in percent)-12.09.2-4.46.72.55.44.74.95.14.6
Currency in circulation (annual growth, in percent)-3.317.2-2.26.62.14.94.24.44.64.1
Gross foreign exchange assets (in millions of U.S. dollars) 2/54,09345,49449,39964,72257,20653,52748,48138,78528,15514,281
Sources: Iraqi authorities; and Fund staff estimates and projections.

This mainly represents the ID standing overnight facilities, US$ deposits of commercial banks, domestic currency deposits, and CBI bills.

Starting 2014 reflects the balances of the Development Fund of Iraq were moved from the Federal Reserve Bank of New York to the CBI as a $ account ($ balances from oil revenues) in May 2014. Starting Q3 2015, SDRs and reserve position in the Fund are excluded from the definition per instruction from the Central Bank of Iraq. SDR and reserve position and all transactions with the Fund were reported on balance sheet in June 2016 temporarily and the issue is under review.

Sources: Iraqi authorities; and Fund staff estimates and projections.

This mainly represents the ID standing overnight facilities, US$ deposits of commercial banks, domestic currency deposits, and CBI bills.

Starting 2014 reflects the balances of the Development Fund of Iraq were moved from the Federal Reserve Bank of New York to the CBI as a $ account ($ balances from oil revenues) in May 2014. Starting Q3 2015, SDRs and reserve position in the Fund are excluded from the definition per instruction from the Central Bank of Iraq. SDR and reserve position and all transactions with the Fund were reported on balance sheet in June 2016 temporarily and the issue is under review.

Table 8.Iraq: Indicators of Fund Credit, 2016–24(In millions of SDRs, unless otherwise indicated)
201620172018201920202021202220252024
Disbursements of Fund credit (SBAand RFQ9105840000000
SBA 2009000000000
In percent of IMF quota (old)000000000
RR 2015000000000
In percent of IMF quota (old)000000000
SBA 20169105840000000
In percent of IMF quota (current)55350000000
Repurchases and Charges (SBA RFI and SDR charges)53351665599057162341212
SBA 20093700000000
Repurchases under the SBA 1/3700000000
RR 2015001114465540000
Repurchases under the RFI 1/001114465540000
SBA 20160005752869021900
Repurchases under the SBA 1/0005752869021900
In percent of IMF quota (current)000332411300
Total charges and interest163045443013200
SDR charges and assessments1510121212121212
Total obligations, in percent of
Exports of goods and services000121000
External public debt000121000
Gross reserves000122100
GDP000010000
IMF Quota (old)43144776602011
IMF Quota (current)32103454431411
Outstanding Fund credit (SBA and RFC1801258622741772909219000
SBA 2009000000000
RR, 201589189178055400000
SBA 20169101,4941,4941,437909219000
Total outstanding Fund credit in percent of
Exports of goods and services344420000
External public debt455320000
Gross reserves675421000
GDP121110000
IMF Quota fold)1522011911497718000
IMF Quota (current)1071431371065513000
Sources: IMF staff estimates and projections.

The SBA and RFI repurchases are based on scheduled debt service obligations.

Sources: IMF staff estimates and projections.

The SBA and RFI repurchases are based on scheduled debt service obligations.

Table 9.Iraq: Inclusive Growth Indicators
_____

Indicator
EMDE

Average
_____

Indicator
EMDE

Average
GrowthLabor Markets (ILO estimates)
GDP per capita growth (percent; 2015–17 average)-6.71.4Unemployment rate (% of total labor force, 2018)7.97.5
Gross Fixed Capital Formation (percent of GDP; 2015–17 average)20.824.1Female unemployment rate (% of female labor force, 2018)12.39.6
Youth unemployment rate (% of total labor force ages 15–24, 2018)16.616.5
Poverty and InequalityLabor force participation (% of total population ages 15+, 2018)42.563.0
Poverty headcount ratio at $3.20/day (percent of population; 2012)Female labor force participation (% of female population ages 15+, 2018)
17.932.912.451.0
Multidimensional poverty (percent of population)14.731.2Youth labor force participation (% of population ages 15–24, 2018)29.643.5
Prevalence of stunting (% of children under 5, 2011)22.622.7
GINI Index (2012)29.539.6Business Environment 1/
Child mortality (per 1,000, 2016)31.236.6Ease of Doing Business (DTF, 2019)44.756.2
Registering Property (DTF, 2019)57.757.4
Human Development and Access to ServicesEnforcing Contracts (DTF, 2019)48.052.4
Human Development Index (2017)0.60.6Paying Taxes (DTF, 2019)63.663.8
Life expectancy at birth (years, 2016)69.969.5
Access to electricity (% of population, 2016)100.078.4Governance 1/
Net school enrollment, secondary, total (% population, 2007)44.863.1Government Effectiveness (WGI, 2017)-1.3-0.5
Individuals using internet (% population, 2016)21.240.8Regulatory Quality (WGI, 2017)-1.2-0.4
Literacy rate (% population, 2013)43.779.1Rule of Law (WGI, 2017)-1.6-0.4
Control of Corruption (WGI, 2017)-1.4-0.3
GovernmentCorruption Perceptions Index (2017)18.036.2
Spending on social safety net (percent of GDP, 2018)2.61.6
Social safety net coverage in poorest quintile (% population, 2012)86.142.3Gender Equity and Inclusion
Government expenditure on education, total (% GDP, 2012)3.94.6Account at a financial institution (female vs male, %, 2014)51.179.6
Health expenditure, domestic general government (% of GDP, 2015)0.82.9Female employment to population ratio (%, 2017)16.546.8
Literacy rate (female vs male, %, 2013)71.686.1
Access to FinanceNet school enrollment, secondary (female vs male, %, 2007)74.797.3
Account at a financial institution (% age 15+, 2017)20.343.0Female seats in Parliament (share of total seats, 2018)26.019.5
Domestic credit to private sector (% GDP, 2015)9.239.8
Loans to SMEs (% of GDP, 2016)1.07.8
Better than EMDE AverageWorse than EMDE Average
Sources: IMF World Economic Outlook, World Bank, World Economic Forum, International Labour Organization, Transparency International, UNDP, Oxfam International.

Indicators use official sources and surveys to summarize perceptions of the quality of governance and business environments.

Sources: IMF World Economic Outlook, World Bank, World Economic Forum, International Labour Organization, Transparency International, UNDP, Oxfam International.

Indicators use official sources and surveys to summarize perceptions of the quality of governance and business environments.

13. Growth is projected to pick up in 2019–20 but taper off over the medium term. Non-oil GDP growth is projected to reach 5½ in 2019—due to better rainfall, a rebound in electricity production6 and significantly looser fiscal policy—with some carryover in 2020. Oil GDP growth will also increase in 2019–20 based on current trends and assuming that the OPEC+ agreement expires, and export capacity improves . However, these transitory factors will unwind and the authorities will likely be unable to sustain capital spending, while borrowing by the public sector will crowd out private credit. Growth will therefore decline significantly from 2021 onward, falling below both population growth and a level required to absorb labor market entrants.

14. There are significant downside risks to the outlook, and in a context of highly volatile oil prices, the major external risk is a fall in oil prices (see Annex V). A shock to oil prices (or volumes) would lower exports and budgetary revenues, leading to an even sharper decline in reserves or higher public debt. Every $1 per barrel decline in oil prices lowers annual oil revenue by 0.6 percent of GDP, thus even modest swings in oil prices could have a material impact, and recent increases in current spending make it harder to adjust. In illustrative scenarios, based on prices ± $10 around staff’s baseline assumptions, if the authorities responded to a negative shock by cutting capital spending to an absolute minimum level, current expenditure could be maintained at the 2019 level only through significant external borrowing and some accumulation of arrears. Under this shock, reserves would decline from $65 billion at end-2018 to $37 billion by end-2020, with public debt reaching 61 percent of GDP (10 percentage points above baseline). On the flip-side, absent policy discipline, a rebound in oil prices, while improving the external and fiscal positions, could blunt incentives for reform and divert spending away from priority investment.

Iraq: Oil Price Scenario Analysis 2018–20

Source: IMF staff calculations.

15. Geopolitical developments and regional risks especially tension between the U.S. and Iran could have significant implications for Iraq. Potential economic spillovers arise from Iraq’s heavy reliance on electricity and gas imports from Iran, which will require careful management in the context of U.S. sanctions. Regional factors and the risk of a resumption of terrorism could also have political and security spillovers with macrocritical effects.

16. Domestic risks remain significant. The effectiveness of the government could be undermined by popular protests absent faster progress at improving public services or rebuilding ISIS-liberated areas. Long-term growth prospects could be undermined if the authorities fail to address absorptive capacity and investment does not pick up, or if the already weak governance and the quality of public institutions were to deteriorate further. The fiscal costs of restructuring and recapitalizing R&R also pose a non-negligible medium-term risk.

Authorities’ Views

17. The authorities had a more positive view than staff on the outlook. They considered medium-term vulnerabilities to be more contained given a more supportive outlook for oil prices and ample buffers. The authorities also viewed risks to be overall on the upside from potentially higher oil prices if market concerns on supply shortages were to re-emerge due to U.S. sanctions on Iran. While cognizant of the challenge posed by the sanctions given dependence on energy imports from Iran, they viewed the current situation as an opportunity to rebalance trade relations with neighboring countries and promote domestic production. That said, the authorities were concerned with the risk that current geopolitical tensions could escalate and potentially jeopardize regional security.

Economic Policies to Support Sustainability and Promote Inclusive Growth

18. Discussions focused on the required changes in policy settings and structural reforms to restore medium-term sustainability and help lay the foundations for inclusive growth. In light of the significant social needs following the end of the war with ISIS, staff encouraged the authorities to strengthen policy frameworks and build fiscal institutions to manage oil revenue more effectively, and presented an adjustment scenario that would help secure macroeconomic stability while ensuring sufficient resources for investment. Staff also emphasized how recalibrating public expenditure coupled with reforms to promote financial inclusion can address weaknesses in the business environment and over time promote private-sector led employment and growth, while the authorities will need to review the adequacy and efficiency of social spending in light of social and demographic strains. Capacity development from the Fund and development partners can help the authorities implement such reforms, with the Fund’s contribution based on a medium-term engagement strategy adapted to Iraq’s circumstances (see Annex I).

19. Staff’s advice is tailored to Iraq’s circumstances as a resource-rich developing country with weak institutions.7 As exhaustibility of oil reserves is not an immediate concern and investment needs are large, Iraq should also use its energy revenues to rebuild physical and human capital. However, investment inefficiencies and limited absorptive capacity imply that investment should be scaled up gradually. A model balancing these considerations and tailored to Iraq’s circumstances implies that it would be optimal for Iraq to run current account deficits of 2.5–4.5 percent at the behest of higher investment over the medium term (see Annex III, Box 1).8 The same considerations have a bearing on fiscal policy frameworks, which should create space for such investment, while dampening procyclicality and reducing vulnerabilities to oil price fluctuations.

20. Rebuilding public institutions will be essential for success, including by reducing vulnerabilities to corruption, and could deliver a significant impetus to long-term growth (see Annex VI). On the fiscal front, improving tax and custom administration has large potential to generate non-oil revenue, while strengthening public financial management would help ensure that public money is appropriately spent, including for capital expenditure projects. Financial sector stability would be enhanced by restructuring public banks and strengthening bank supervision and frameworks for AML/CFT. Moreover, steps to strengthen the rule of law will be essential to encourage private-sector investment. Staff assesses that a comprehensive package of governance reforms that reduces fiscal leakages and enhances private investment would add 10–20 percent to output over 10 years (see Box 1).

A. Building a Robust Fiscal Framework to Manage Oil Wealth

21. Staff encouraged the authorities to adopt a risk- and rules-based approach to fiscal policy as part of broader fiscal reforms to manage oil revenue more effectively. This approach entails building fiscal buffers to mitigate the impact of oil price shocks on spending, and moving to a multi-year fiscal and budget framework based on robust budget processes and reinforced by fiscal rules. Staff analysis shows that expenditure rules, if well designed and backed by political commitments, can help Iraq reduce tendencies for procyclicality, shift to a more growth-friendly composition of expenditure, and encourage complementary public financial management reforms.9

22. Committing to a fiscal rule in the form of a ceiling on current primary spending of the central government would support efforts to create space for scaled up public investment. Excluding capital expenditure from the expenditure ceiling would help ensure adequate space to rebuild the country after the war and close infrastructure gaps. It would also prevent the buildup of fiscal risks during oil price booms—by capping wages and other outlays that are difficult to reverse during shocks. This would support medium-term planning, dampen pro-cyclicality and support the authorities’ social objectives. Line ministries would be expected to commit to these ceilings as part of the budget preparation process and develop medium-term plans on this basis. Staff emphasized that the ceiling on current spending should be supported by measures to strengthen public expenditure management to ensure efficiency of capital spending, and prevent spending from being reclassified to circumvent the rule.

Box 1.Quantifying the Macroeconomic Benefits of Improved Governance1

The macroeconomic implications of improved governance can be assessed using the Debt, Investment, Growth and Natural Resources (DIGNAR) model developed by Melina and others (2016). This general equilibrium model estimates the impact of three types of governance reforms on output, private investment, private consumption and debt: (i) a reduction in bribes and other distortions that discourage private firms from investing and expanding; (ii) an improvement in public investment spending efficiency that facilitates an increase in the public capital stock; and (iii) an improvement in tax revenue mobilization that reduces evasion and widens the tax base.

The model is calibrated to capture the main features of the Iraqi economy. Iraq’s main macroeconomic aggregates are set to their 2010–18 averages, and the initial level of private investment is set at its observed value of 8½ percent of GDP. For public investment efficiency, 26.9 percent is taken as the starting point based on the lower bound of estimated investment inefficiencies for the MENA region by Pritchett (2000). Given data limitations, consumption tax and personal income tax collection efficiencies are set at a starting point equivalent to the first quartile of the Emerging Market Economies’ (EMEs) distribution, which are 35 percent and 4 percent respectively.

The model simulates two reform scenarios over ten years: An optimistic scenario where each indicator improves enough to advance Iraq to the next quartile of the EMEs’ distribution; and a moderate scenario, where the improvement is half that of the optimistic. The optimistic scenario implies that: (i) the ratio of private investment to GDP increases to 16 percent, the second quartile (median) of the EMEs’ distribution; (ii) public investment efficiency rises to 48 percent, the first quartile of the EMEs’ distribution; and (iii) the government’s efficiency in collecting consumption and personal income taxes rises to 55 percent and 8 percent, respectively, the median for EMEs.2

The simulations imply that a comprehensive reform package improving all three governance channels could add about 2 percentage points to growth each year and reduce public debt significantly over 10 years. The model assesses the impact of reforming each aspect of governance on its own (keeping the other two unchanged), as well as the combined impact of reforming all three elements simultaneously (Table 1, Figure 1). Focusing on the combined impact, the optimistic scenario shows private investment doubling in real terms over 10 years, while output and private consumption each increase by about 20 percent. These results translate into additional annual growth of 2 percent. In addition, public debt falls by 32 percent of GDP over 10 years, allowing the tax rate to fall given the fiscal reaction function, which further stimulates private demand. The moderate scenario delivers still significant results, with 1 percent of additional annual growth and a one-fifth reduction in public debt-to-GDP over ten years. Overall, the largest contribution to the improvement in macroeconomic conditions stems from removing the distortions affecting private firms` decisions to invest. Improving public investment efficiency also has a non negligible impact on all variables, while enhancing the efficiency of tax collection has a significant impact on debt, highlighting the benefits of a comprehensive reform package. Thus, reducing distortions and inefficiencies, caused at least in part by weak governance, would entail large positive macro-fiscal benefits for Iraq.

10-Years’ Effects of Improving Governance
Firms’ DistortionPublic Investment EfficiencyRevenue MobilizationAll Areas of Governance
Optimistic ScenarioModerate ScenarioOptimistic ScenarioModerate ScenarioOptimistic ScenarioModerate ScenarioOptimistic ScenarioModerate Scenario
Private Investment94.8493.671.640.530.39100.551.6
Private Consumption11.76.724.442.221.040.4719.610.2
Output14.98.022.911.420.530.2419.710.2
Change in Public Debt-20.7-13.1-9.61-4.70-11.9-7.11-32.1-21.5
Note: Private investment private consumption and output are in percentage deviations from the initial year. The change in public debt is expressed in percent of GDP.
Note: Private investment private consumption and output are in percentage deviations from the initial year. The change in public debt is expressed in percent of GDP.

Effects of Reforms in All Areas of Governance

Source: IMF staff estimates and calculations.

1 Prepared by Giovanni Melina and Alessandro Cantelmo (RES).2 For the moderate scenario: (i) private investment-to-GDP rises to 12 percent; (ii) public investment efficiency rises to 37.5 percent; and (iii) consumption tax and personal income tax collection efficiency rise to 45 percent and 6 percent, respectively.

23. In line with this approach, staff presented a macroeconomic framework involving a gradual fiscal adjustment to restore and maintain sustainable fiscal and external positions. A phased adjustment of 11 percent of non-oil GDP is proposed over the medium term. A ceiling on current primary spending, based on annual nominal growth of 2 percent during 2020–24, is calibrated in line with this target. Spending measures focusing on containing the growth in the wage bill (1128) and lowering subsidies to the electricity sector (1130) would deliver most of the adjustment needed in current spending. The proposed adjustment would help keep public debt on a declining path and maintain reserves at adequate levels. The current account would remain in deficit over the medium term in this scenario, but at a level consistent with the current account norm.

Selected Indicators: Baseline(In percent of GDP; except where indicated)
Projections
201620172018201920202021202220232024
Total revenue26.833.039.840.539.637.936.535.534.6
of which non-oil4.04.23.13.33.33.43.43.53.5
Total expenditure40.734.632.044.643.141.240.540.540.5
of which current29.326.426.733.934.733.633.533.733.9
of which wage bill15.614.514.217.417.417.517.417.517.6
of which capital11.58.35.310.68.47.57.06.86.6
of which non-oil4.32.81.45.13.02.31.91.91.8
Overall deficit-13.9-1.67.9-4.1-3.5-3.3-4.0-5.0-5.9
Public debt64.258.949.351.450.550.651.553.656.4
Current account-8.31.86.9-5.2-4.2-4.3-4.6-5.3-6.0
International reserves (in billions of U.S. dollars)45.549.464.757.253.548.538.828.214.3
International reserves (in percent of ARA)173.6174.4208.4186.6165.9146.1112.280.739.7
Memorandum Items
Fiscal buffer (in trillions of Iraqi Dinars)4.07.220.012.410.48.46.45.44.4
Non-oil primary balance (in percent of non-oil GDP)-42.4-42.4-41.8-51.7-46.0-43.6-41.8-41.0-40.2
Primary current spending (excluding payment to Kuwait)
Annual nominal growth (in percent change)5.0-0.913.428.56.65.34.65.25.5
In percent of non-oil GDP42.841.645.754.052.651.049.548.647.9
Nominal GDP (in trillions of Iraqi Dinars)207231265265285300316332350
Real GDP Growth (in percent change)15.2-2.5-0.64.65.32.62.32.12.1
Sources: Iraqi authorities; and IMF staff calculations.
Sources: Iraqi authorities; and IMF staff calculations.
Selected Indicators: Adjustment Scenario(In percent of GDP; except where indicated)
Projections
201620172018201920202021202220232024
Total revenue26.833.039.840.639.838.036.635.634.6
of which non-oil4.04.23.13.43.53.84.24.85.3
Total expenditure40.734.632.043.642.640.338.937.736.0
of which current29.326.426.733.933.331.129.828.427.1
of which wage bill15.614.514.217.416.315.615.014.213.4
of which capital11.58.35.39.79.29.29.19.39.0
of which non-oil4.32.81.44.13.84.04.14.64.5
Overall deficit-13.9-1.67.9-3.1-2.7-2.2-2.3-2.1-1.5
Public debt64.258.949.351.150.450.249.849.949.2
Current account-8.31.86.9-4.7-3.4-3.6-3.6-3.1-3.1
International reserves (in billions of U.S. dollars)45.549.464.759.460.160.761.565.670.2
International reserves (in percent of ARA)173.6174.4208.4193.7186.2182.5176.2184.5189.5
Memorandum Items
Fiscal buffer (in trillions of Iraqi Dinars)4.07.220.014.015.016.017.522.528.0
Non-oil primary balance (in percent of non-oil GDP)-42.4-42.4-41.8-50.1-44.5-41.2-37.6-34.3-30.9
Primary current spending (excluding payment to Kuwait)
Annual nominal growth (in percent change)5.0-0.913.428.52.02.02.02.02.0
In percent of non-oil GDP42.841.645.754.050.446.843.440.237.2
Nominal GDP (in trillions of Iraqi Dinars)207231265265285302322345371
Real GDP Growth (in percent change) 1/15.2-2.5-0.64.65.33.03.13.23.3

Staff uses multiplier analysis to estimate the impact of capital spending on non-oil GDP growth, based on empirical studies on the MENAP oil exporters (see Cerisola and others 2015). In view of Iraq’s limited absorption capacity, staff assumes that the multipliers operate with a lag. Staff proposal to under-execute capital expenditure will likely have no impact on growth given the large increase planned in the 2019 budget and scope to rationalize lower priority projects.

Sources: Iraqi authorities; and IMF staff calculations.

Staff uses multiplier analysis to estimate the impact of capital spending on non-oil GDP growth, based on empirical studies on the MENAP oil exporters (see Cerisola and others 2015). In view of Iraq’s limited absorption capacity, staff assumes that the multipliers operate with a lag. Staff proposal to under-execute capital expenditure will likely have no impact on growth given the large increase planned in the 2019 budget and scope to rationalize lower priority projects.

Sources: Iraqi authorities; and IMF staff calculations.

24. The proposed adjustment and financing mix would aim to achieve the following fiscal policy objectives:

  • Fiscal buffer. An appropriate target would be the equivalent to one-year revenue loss from a permanent oil price shock (equivalent to one standard deviation of historical forecast errors), and is estimated at 17 percent of non-oil GDP. While a larger buffer target would mitigate oil risks further, it would reduce the space for essential spending. Staff suggested making gradual progress towards this target by increasing the fiscal buffer (cash balances of the government at the CBI) from ID 20 trillion in 2018 to ID 28 trillion by 2024 (11 percent of non-oil GDP). The buffer could be built faster to reach the desired target (or targeting more than a year of oil revenue loss) if oil prices are higher than expected or capital expenditure is under-executed, whereas if an oil price shock materializes the buffer could be used to protect capital spending.
  • Capital spending. The adjustment would create space for about $22 billion of capital spending over the baseline, close to a quarter of the aggregate reconstruction cost estimated by the World Bank. Staff suggests a gradual ramp up of capital spending allocations—to 4.5 percent of GDP by 2024—as it will take time to implement the structural and institutional reforms required to improve absorptive capacity (see ¶31).
  • Financing mix. Staff suggests a financing mix that would help build the buffer, while largely eliminating central bank financing to support foreign reserves and avoid overheating. To this end, disbursement of pledged donor financing to support higher capital spending should be expedited,10 while domestic financing should rely more on domestic banks, which have room to retain some T-bills—departing from the triangular operations in which all T-bills purchased by banks were rediscounted at the central bank.

25. Expanding non-oil revenues would create further fiscal space to help achieve the above objectives and lower vulnerabilities to oil price shocks. Revenues from sales taxes adopted as part of the 2018 budget fell short of expectations because of a lack of compliance procedures, and most of these measures were cancelled in the 2019 budget. The way forward should involve developing a standalone tax bill to reintroduce well-articulated measures and clear penalties, and ensuring adequate resourcing of the large taxpayers’ office.

26. Prioritizing capital spending in 2019 will help advance the adjustment process. Given the long lead time for the preparation and approval of projects, and weaknesses in procurement procedures, the capital expenditure budget cannot be executed this year without efficiency losses, calling for careful identification and focus on key projects to ensure their completion, while delaying lower priority projects. In this regard, a decision to transfer unexecuted capital spending to spending units’ trust funds will weaken budgetary controls.

Authorities’ Views

27. The authorities were unconvinced of the urgent need to modify fiscal policy settings. They cited higher oil prices as well as their track record of underexecuting the budget as likely sources for budgetary savings in the near term. The authorities also viewed reining in current spending as undesirable politically and socially at this stage, and signaled their intention for another expansionary budget in 2020. That said, they agreed on the need for reforms over the medium term, particularly on non-oil revenue mobilization, subsidies, and civil service. The authorities agreed on the benefits of adopting fiscal rules, and expressed interest in integrating them into their medium-term fiscal strategy.

B. Reallocating Public Expenditure to Promote Inclusive Growth

28. Well-structured measures are essential to contain the rapid growth in the public wage bill, and deliver a large and sustainable reduction over time. The wage bill, already one of the highest in the world, is subject to further pressures in the coming years due to the large and rising number of labor market entrants as well as pressures to convert tens of thousands of contractual and daily workers in the public sector into regular employment11 Staff proposes a mixture of short-term measures to avert a further large increase in the wage bill in 2020, as the authorities work on more durable measures that will pay off over time (see Annex VII).

  • To dampen spending pressures in the short run, the authorities could focus on compensation measures such as capping allowances, bonuses and other non-base wage payments, as well as using natural attrition to avert a further increase in the size of the payroll.
  • Structural measures will be essential to achieve durable savings over the medium term, based on a functional workforce review as well as deeper civil service reform once new HR management and information systems are in place. Biometric systems and other technological solutions will support these reforms, while also generating savings by eliminating ghost workers and double dippers.

Public Sector Wage Bill

(In percent of GDP, 2016 except where indicated)

Sources: World Economic Outlook; and IMF staff calculations.

29. The electricity sector is a major drag on public resources. It incurs a large operational deficit covered through direct budgetary transfers, borrowing from the Ministry of Oil (MoO) and arrears to Iran. The sector also receives oil and gas products from the MoO at below market prices: it paid 1.8 percent of GDP in 2018 for these inputs, compared with 3.8 percent of GDP if they were valued at market prices.

Summary Budget and Financing of the Electricity Sector, 2018(In percent of GDP)
Tariff Collection0.4
Expenditures2.6
Deficit-2.3
Total Financing2.3
Transfer from Ministry of Finance1.2
Project financing and suppliers credit0.3
Debt to Ministry of Oil0.8
Payment of old arrears to Iran (- means payment)-0.1
Accumulation of new arrears to Iran0.3
End of year balance (- means surplus)-0.2
Sources: Iraqi authorities; and IMF staff calculations.
Sources: Iraqi authorities; and IMF staff calculations.

30. Ambitious reforms in the electricity sector can deliver budgetary savings while also achieving the government’s goal of providing a more stable electricity supply. The authorities will need to address the main factors behind large budget costs including modest tariff rates, chronic non-payment of electricity bills, poor maintenance and over-reliance on expensive generation sources together with significant losses materializing in the generation and distribution process. Cross-liabilities between the Ministries of Electricity, Oil, and Finance totaled nearly 5 percent of GDP by end-2018, and should be settled. Curtailing gas flaring to capture more domestic natural gas is essential, and will require significant capital expenditure. The allocation of contracts in 2019 to rehabilitate moth-balled plants and improve generation capacity is a welcome development, and the authorities should continue to explore technological solutions to increase revenue collection. It would be important to ensure that the poorest and most vulnerable are protected throughout the reform process.12

Cost of Electricity Generation, 2018(In percent of GDP)
Providing MinistryMoE RateIf Priced at International Prices
Imported Electricity from IranMoF [budget transfer]0.10.1
Purchased Electricity from IPPsMoF [budget transfer]0.30.3
Imported Gas from IranMoF [budget transfer]0.60.6
Dry Gas from BGCMoO [debt]0.20.4
Imported Gas OilMoO [debt]0.20.2
Fuel GasMoO [debt]0.30.6
Crude OilMoO [debt]0.11.6
Total Support from Ministries1.83.8
Sources: Iraqi authorities; and IMF staff calculations.Note: As reported by the authorities, MoE debt stock rose from ID 9.3 trillion to ID 12.7 trillion in 2018, implying a flow of ID 3.4 trillion. This is higher than the ID 2.1 trillion of debt to MoO implied by this table.
Sources: Iraqi authorities; and IMF staff calculations.Note: As reported by the authorities, MoE debt stock rose from ID 9.3 trillion to ID 12.7 trillion in 2018, implying a flow of ID 3.4 trillion. This is higher than the ID 2.1 trillion of debt to MoO implied by this table.

31. Improvements in public investment management would help strengthen absorption capacity and ensure that resources are well spent. Efforts to prioritize capital spending in the context of medium-term fiscal/expenditure frameworks and based on cost-benefit analysis would be enhanced by improving pre-investment studies, deepening quantitative analysis underpinning feasibility studies, introducing independent reviews of appraisals and curbing political interference in prioritization decisions. Given the time it may take to tackle these weaknesses, some investment projects may need to be rephased. As absorptive capacity improves, the authorities should streamline procedures for the approval of public projects, while maintaining adequate safeguards in place, and strengthen capacity to comply with the terms and conditions of donor financing. Such reforms would help improve the execution of allocated capital expenditure, making the budget a better predictor of actual outcomes.

32. Public financial management (PFM) reforms are essential to ensure public spending is appropriately monitored, and can help reduce vulnerabilities to corruption (see Annex VI). These include:

  • Implementing the newly adopted GFML, including by adopting decrees or secondary legislation. Key gaps should be addressed, including strengthening and firmly institutionalizing rules for the vetting and monitoring of guarantees, and capacity development from the Fund and other partners can support these efforts.
  • Accelerating progress on implementing IFMIS, a World Bank-led project to replace the current paper-based systems with more robust systems that are essential to establish a modern PFM system.
  • Establishing commitment controls and reinforcing monitoring of arrears to help ensure a robust mechanism to prevent a recurrence of arrears in the event of future shocks.
  • Strengthening cash management through regular sweeping of spending units’ cash balances as a step towards the longer-term goal of establishing a Treasury Single Account (TSA).

Authorities’ Views

33. The authorities viewed staff’s proposals on public-sector wages as desirable and feasible over the medium-term but politically difficult in the near term. They highlighted the social pressures to increase employment in the public sector to address unemployment, achieve justice for some groups that were affected by past consolidation including militia forces that helped defeat ISIS, and meet current legal requirements to absorb graduates of certain specializations. The authorities thought some of the proposed measures, such as freezing allowances and bonuses, could be taken starting in 2021 while more structural measures should be introduced over the medium term as part of a broader review of public sector functions and size. They highlighted the recently enacted civil service law as a starting point for the reform agenda in this area.

34. The authorities broadly agreed with staff’s assessment and policy recommendations regarding electricity. They emphasized the priority given to the sector and the need to look into subsidies as part of a comprehensive review of the budget. The high cost reflects structural factors that will require time to address, including a multi-year agreement to import Iranian gas at prices currently above international levels. They also acknowledged the need to address debt between ministries and will reactivate work by a committee formed to address these cross liabilities.

C. Enhancing Financial Stability and Financial Intermediation

35. An overhaul of the banking sector is essential to maintain financial stability and to transform the sector into an effective vehicle for intermediation that also supports inclusive growth. The two largest banks—Rafidain and Rasheed (R&R)—have portfolios heavily weighted towards public-sector assets, some of which are not being serviced, which limit their capacity to lend until they are restructured and recapitalized. A number of private banks are struggling with sharply reduced FX trading incomes while working out NPLs that emerged during the 2014–16 crisis. These weaknesses coupled with shortcomings in the financial architecture and legal framework help explain why lack of access to credit is a material weakness of the business environment.

36. The long-delayed restructuring of the public banks is beginning, and well-structured plans are required to bring it to a successful conclusion. R&R have contracted suppliers for core banking systems, and segregated legacy assets and liabilities into ‘bridge branches’. The Bureau of Supreme Audit (BSA) is working on finalizing their accounts for 2014 and subsequent years. Once the core banking systems are fully operational,13 the two banks should be audited to international standards, which would allow their capital needs to be assessed accurately. In the interim, and to prevent a further deterioration in their financial conditions, the authorities should strengthen governance and oversight over the two banks and develop long-term strategies for their future, while abstaining from piecemeal capital injections. All these steps would require coordinated government action in light of the potential fiscal implications of bank restructuring.

37. Strengthening banking supervision, with an increased focus on risks in the public banks, is essential to support stability during this transitional phase. Building on steps to improve the prudential framework, staff encouraged the authorities to commission a targeted quality review of the public banks’ main assets, especially loans to SOEs that are government guaranteed (and therefore zero risk weighted), yet are not being fully serviced. Such a review would help guide supervisory efforts, lower the risks of a further deterioration in the public banks’ balance sheets, and facilitate the transfer of assets to the core banking system. To reduce risks in the private banks, staff encouraged caution in licensing new banks, and urged the authorities to strengthen frameworks for handling troubled banks.

38. Tackling weaknesses in the banks coupled with wider structural reforms can help the authorities realize their goals of promoting financial development and inclusion.14 Work is underway to strengthen payment systems and encourage salary payments directly into bank accounts. Fintech can help banks strengthen risk management and channel additional financial resources, and in view of the extensive wireless coverage, there is considerable potential to improve financial inclusion by developing mobile banking. Improving credit information and strengthening legal procedures could also encourage banks to relax collateral requirements and facilitate access to credit. Plans are underway to develop a deposit insurance scheme, which would help level the playing field across the banking sector, but requires effective bank supervision to limit risks. In helping to boost the currently very low level of SME financial inclusion, such measures can add a significant impetus to growth and employment.

SME Financial Inclusion Index

(On a 0 to 1 scale)

Source: IMF Departmental Paper.

Growth Benefits of Closing SME FI Gaps

(Increase in real GDP; in percentage points over global average)

Source: IMF Departmental Paper.

39. Building on improvements to the legal and institutional framework for AML/CFT, staff emphasized the importance of effective implementation in this area (see Annex VI). In 2018, the Financial Action Task Force (FATF) removed Iraq from its list of jurisdictions with strategic deficiencies in recognition of the new AML/CFT law adopted in 2015, which brought the legal framework into line with international standards, and other reforms including the establishment of institutions to implement the law. However, the country continues to face significant money laundering and terrorist financing (ML/TF) risks from the informal economy and the cross-border movement of cash. Supervision of financial institutions is not yet sufficiently effective to safeguard the financial system against illicit flows and criminal activity.

40. The authorities have made some progress in implementing the recommendations of the 2016 safeguards assessment of the CBI. Amendments to the law on the Central Bank of Iraq to strengthen CBI governance have been enacted, and the revised audit committee charter now prohibits CBI executive representation on the committee. However, progress in strengthening the capacity of internal audit and financial reporting has been slow.

Authorities’ Views

41. The authorities agreed on the need to address weak banks. They agreed on the scope for greater coordination between the Ministry of Finance, CBI, and BSA in restructuring R&R. They considered the progress on procuring core banking systems for the two banks as an important first step. The authorities concurred that the financial system is currently overbanked. They expect the number of private banks to decline as non-profitable banks merge with others or exit the system. They expressed the need for continued strengthening of their capacity on banking supervision and resolution with Fund support.

42. The authorities also agreed on the importance of strengthening financial development and inclusion. They saw the main impediments as a cash-based culture that narrows the funding base, and pervasive non-repayment of credit due to sluggish legal processes and weak enforcement. They cited progress through recent measures to encourage deposits including paying public salaries through the banking system, and passing the law establishing a deposit insurance company. The authorities also highlighted the credit bureau system at the CBI, which they plan to eventually transfer to the private sector. The CBI considered the weak credit to the private sector to be mainly due to weak demand and the limited capacity in the private sector to prepare financial statements and viability studies. They cited limited uptake on the CBI’s ID1 trillion initiative to finance SMEs and the difficulty in finding bankable projects.

D. Anti-Corruption

43. Iraq has begun developing an anti-corruption framework, and there is scope for it to be strengthened. A Commission on Integrity (COI) was set up in 2011 with the tasks of corruption prevention and enforcement, and it has investigated several high-profile corruption cases. Legislation to criminalize illicit enrichment, trading in influence, embezzlement, and all forms of bribery has been drafted but not yet enacted. Public officials convicted of corruption are currently not barred from holding office. Staff emphasized the importance of tackling these gaps in the legal and institutional framework.

44. There is also considerable scope to improve co-ordination and streamline institutional structures. A number of public agencies are involved in anti-corruption efforts, but working largely in isolation and sharing information to a limited degree. The High Council for Combatting Corruption, which was established this year, should work closely with the parliamentary Integrity Committee to promote coherent anti-corruption laws and policies. The agencies involved in enforcement should co-ordinate to avoid duplication of tasks. E-governance can support these efforts by simplifying procedures and limiting opportunities for discretion.

45. Iraq has developed a system of asset declarations, and staff highlighted reforms that would strengthen its effectiveness. A large number of public officials are currently required to disclose their assets, but failures to submit disclosures go largely unpunished due to limitations on the COI’s powers. Asset declarations are not adequately verified, nor shared with relevant public authorities. Staff emphasized that the system should be focused on public officials most at risk of corruption, with sufficient resources allocated for digitalizing and verifying submissions. Clear penalties should be established and enforced for officials who do not submit declarations. Over time, asset declarations should be published.

Authorities’ Views

46. The authorities agreed that combatting corruption is a priority. In doing so, they are focusing on strengthening public institutions. At the same time, they see a need to streamline the anti-corruption framework to make it more effective and less onerous for economic activity. They consider reforms aimed at government digitization as key towards limiting the scope for corruption. They also cited their continued progress on AML/CFT with the help of international partners as an important means for cracking down on the transfer of illicit gains.

E. Future Fund Engagement

47. Iraq meets the criteria for initiating post-program monitoring (PPM). Its outstanding obligations to the Fund are expected to remain above the SDR 1.5 billion threshold until April 2020. Moreover, there are no circumstances that would indicate that PPM is not warranted.

Staff Appraisal

48. The end of the war and higher oil prices have given the government an opportunity to rebuild the country and tackle social issues, but the challenges it is facing are formidable. Major capital investments are required to repair war damage, improve electricity and other public services and cope with the strains from a young and fast-growing population. But strong spending pressures across the board and the continuation of the current procyclical fiscal expansion will increase the country’s exposure to oil price shocks, erode reserves and could frustrate the government’s chances of achieving these goals. Public institutions will find it hard to prioritize competing demands in a way that consistently promotes inclusive growth.

49. In a context of elevated oil price volatility, maintaining medium-term sustainability while addressing social objectives will require changes in policy settings and structural reforms, including with respect to governance. Fiscal policy should be anchored on scaling up capital spending and building fiscal buffers within a sustainable framework. The restructuring of the financial sector should be accelerated. Taking firm steps to strengthen governance is essential to enable public institutions to deliver on the government’s social objectives and lower risks of corruption. Governance reforms are also key to improving the business environment, and can provide a significant impetus to long-term growth. Capacity development from the IMF and development partners can support these efforts.

50. Staff recommends adopting a more risk- and rules-based approach to fiscal policy. Containing current spending and boosting non-oil revenue will create space for investment, while lowering the deficit, keeping public debt on a declining path and building fiscal buffers. This would help avoid pro-cyclicality and lower Iraq’s vulnerability to oil price shocks. The authorities should strengthen public financial management frameworks, and adopt necessary decisions and secondary legislation to implement the recently adopted general financial management law, in particular with regards to the vetting and monitoring of guarantees.

51. To achieve this, staff also encourages the authorities to commit to medium-term ceilings on current spending, supported by well-structured and carefully sequenced measures. The focus should be on the wage bill, given its existing size and heavy pressure to add staff to the payroll. Measures in the short term to cap allowances and bonuses would give the authorities space to develop structural measures including through civil service reform. Significant reforms are also required to reduce the operational deficit in the electricity sector while expanding supply. The authorities should review the adequacy and efficiency of social spending to help ensure that poor and vulnerable groups are protected throughout such reforms to current expenditure.

52. Restructuring of the public banks coupled with enhanced bank supervision is essential to preserve financial stability. The key next step is to install core banking systems in the two large public banks, which is a pre-requisite for these banks to be audited, restructured and eventually recapitalized. Steadfast supervision would help prevent a further deterioration in their balance sheets during this process, and to monitor vulnerabilities among private banks.

53. Successful restructuring of the banks coupled with structural reforms can help the authorities address long-standing problems with financial inclusion, including access to credit. Improving credit information and strengthening legal procedures would encourage banks to relax collateral requirements and facilitate access to credit. The planned deposit insurance scheme would also help level the playing field across the banking sector, but effective supervision is essential to limit risks. By strengthening SME financial inclusion, such efforts can have a significant impact on growth and employment.

54. Combatting corruption requires modifications to the legal framework and closer co-ordination between public agencies. A sound legal regime criminalizing all corruption offences and setting out effective sanctions will be necessary; public officials convicted of corruption should be prohibited from holding office. The authorities should also develop coherent national anti-corruption policies, based on a deeper understanding of the risks, and relevant agencies should coordinate more closely, with enhanced information exchanges. The system of asset declarations should be progressively strengthened by targeting the officials most exposed to corruption, sanctioning failures to submit declarations, digitalizing declarations and moving eventually to publication of asset declarations.

55. Bolstering AML/CFT implementation would help enhance the integrity of the financial system and support anti-corruption efforts. The Central Bank of Iraq (CBI) should implement risk-based AML/CFT supervision of banks and exchange houses to improve compliance with preventive measures, including those related to politically exposed persons and beneficial ownership. Such efforts would help identify proceeds of corruption and ease pressure on correspondent banking relationships. The CBI should also step up efforts to implement outstanding safeguards recommendations.

56. The Managing Director recommends the initiation of post-program monitoring. The first PPM Board discussion is envisaged before end-2019. It is further proposed that the Article IV consultation cycle revert to the 12-month cycle.

Annex I. Capacity Development Strategy

The Fund and other development partners have provided significant capacity development in recent years, especially in the context of the SBA. In light of the government’s objectives and the challenges facing Iraqi authorities, major priorities for Fund Capacity Development (CD) over the medium term are likely to include public financial management, revenue administration, bank supervision and statistics.

Overview of Capacity Development Efforts

1. CD activities in recent years have aimed at helping the authorities deliver on policy commitments under the 2016–19 SBA while also responding to their specific requests:

  • Reflecting commitments to address weaknesses in public financial management, the Fund has provided extensive technical assistance to help control arrears, establish commitment controls and take steps towards the establishment of a treasury single account (TSA). The Fund has also provided advice on Iraq’s PFM law.
  • Similar, program commitments to diversify revenue sources have been supported by advice to develop and strengthen indirect taxation.
  • In the financial sector, technical assistance has been directed to strengthening prudential regulation, bank supervision and the AML/CFT framework.

2. Much of the Fund’s TA has had a training component. However, the authorities have made more limited use of Fund training online or at the Center for Economics and Finance (CEF) training center.

3. The Fund has worked closely with development partners in the delivery and implementation of TA. World Bank staff have joined Fund TA missions, such as to develop a chart of accounts, which is a critical pre-requisite for the World Bank-led IFMIS project. Other partners, such as JICA, have financed support for debt management, while resident advisors funded by other partners have helped support practical implementation.

Priorities for IMF Technical Assistance and Training

4. The government’s strategy of rebuilding the country will require significant capacity building effort alongside a reorientation of the budget towards capital spending. Maintaining fiscal discipline in a context of rising expenditure will involve a continued focus on budget execution and control, including to ensure that off-budget spending and guarantees are adequately monitored, and steps to strengthen non-oil revenue. Thus, the main priorities for Fund fiscal TA are likely to include public financial management, revenue administration, and over time public investment management. Capacity development to support bank supervision should continue.

5. Improvements to statistics would support policy-making in Iraq. The Central Statistics Organization (CSO) faces resource and technical expertise constraints, with progress hampered by weaknesses in interagency data sharing and issues surrounding data collection responsibilities. Capacity development should focus in the near term on real sector and external sector statistics.

Annex II. Response to Past Fund Policy Advice
Key RecommendationsAuthorities’ Response
Fiscal. Find fiscal space needs to enhance human capital and rebuild the physical capital of the country. Tackle the low level of non-oil tax revenue and very high level of public consumption to help create the fiscal room to finance growth-enhancing investment.Fiscal. Limited progress at building fiscal space or controlling public consumption; current spending was increased sharply in 2018 and 2019. The authorities introduced new non-oil taxes in 2018, but initial revenues were limited, and a number of measures have been revoked.
Financial stability. Bolster supervision. Move forward with plans to restructure the state-owned banks. Strengthen the legal framework of the Central Bank. Eliminate an exchange restriction and an MCP.Financial stability. Steps have been taken to strengthen supervision. The authorities have segregated some legacy assets of the state-owned banks to bridge branches, but a comprehensive restructuring plan has yet to be implemented. All previously identified exchange restrictions have been eliminated.
Governance. Accelerate implementation of AML/CFT and anti-corruption measures.Governance. Iraq was removed from FATF monitoring in 2018, signaling progress at AML/CFT implementation. A new High Council on Combatting Corruption was created in 2019, but a significant step-up in anti-corruption enforcement has yet to materialize.
Structural reforms. Implement reforms to improve the investment climate, diversify the economy, and achieve sustainable growth.Structural reforms. Limited progress.
Public financial management. Complete a regular inventory and pay down any arrears. Strengthen expenditure commitment and cash management to prevent the accumulation of new arrears. Address weaknesses in administrative capacity and data provision. Implement the budget-sharing agreement between the Federal and Kurdistan Regional governments.Public financial management. The authorities have generally kept arrears under control, although there has been limited progress at developing commitment controls or strengthening cash management. Budget transfers to KRG were progressively restored during 2018, and have been included in the 2019 budget. A new PFM law was adopted in May 2019.
Annex III. External Sector Assessment

Staff assesses the external position in 2018 to be substantiaiiy stronger than suggested by fundamentals and desirable policy settings. However, this is expected to reverse in 2019, with the current account (CA) weakening significantly, reserves falling, and the REER moving into overvalued territory. Ensuring external stability in the medium term will critically hinge on fiscal adjustment, to bring the CA and REER back into line with fundamentals, and maintain reserve adequacy.

1. From a surplus in 2018, Iraq’s CA balance is expected to worsen significantly in 2019 and average a deficit of 5 percent of GDP over the medium term. In 2017, Iraq’s CA registered a surplus of 1.8 percent of GDP, from a deficit of -8V4 percent of GDP in 2016, on the back of higher oil prices and fiscal consolidation under the program, while oil export volumes remained flat year on year. In 2018, preliminary estimates suggest that the surplus increased to 6.9 percent of GDP driven by a large increase in oil prices (by USD 16 year on year), with a minor increase in oil export volumes also contributing. Looking forward, the expected decline in oil prices in 2019 (by USD 9 year on year) together with fiscal loosening are projected to dramatically reverse the CA surplus this year to a deficit of 5¼ percent of GDP, despite a projected increase in oil export volumes of 4 percent year on year. Thereafter, the CA balance is expected to remain in deficit through the medium term, averaging -5 percent of GDP, with a gradual increase projected for oil export volumes while prices will remain roughly flat. The real effective exchange rate (REER) appreciated by 4¾ percent year on year in 2018, continuing a trend seen since 2013 (the REER has appreciated by 12½ percent in the past five years) mostly due to movements in the nominal effective exchange rate (NEER) dampened by inflation differentials.1

Real and Nominal Effective Exchange Rate

(Index: 2012= 100)

Source: IMF Information Notice System (INS).

Financing Needs, Oil Prices and Reserves

(In percent of GDP)

Sources: World Economic Outlook; and IMF staff estimates.

2. Iraq’s international reserves, while adequate in 2018, are expected to decline precipitously to levels well below conventional and IMF adequacy metrics over the medium term, given weak oil price prospects and rising financing needs. After increasing to $64.7 billion (29 percent of GDP) in 2018, reserves are expected to fall over the medium term to $14 billion (4¾ percent of GDP) in 2024. Oil prices are expected to decrease marginally from 2019–24, providing no contribution to reserve accumulation, while higher financing needs from the growing fiscal deficit and rising external debt service (from 1¼ percent of GDP in 2018 to almost 3 percent of GDP in 2024) will serve as a drain. Reserves will dip below the IMF’s augmented reserve adequacy metric for oil exporters (which adds a buffer to hedge against lower than projected oil prices) in 2019, and by 2023 they will fall to a level well below all IMF and traditional adequacy metrics.

Reserve Adequacy Indicators, 2017–24
Projections
20172018201920202021202220232024
Reserves in USD billion49.464.757.253.548.538.828.214.3
Reserves in months of imports of goods and services7.38.06.86.25.54.22.91.4
Reserves in percent of external debt service coming due2,0051,8671,045780522501364166
Reserves in percent of reserve money88.9109.294.283.572.355.138.118.5
Reserves in percent of broad money63.080.369.361.052.439.627.113.1
Reserves in percent of the IMF RA metric 1/1742081871661461128140
Reserves in percent of the augmented IMF RA metric 1,2/113111988168543819
Sources: Iraq authorities; and Fund staff estimates and projections.

Reserves within 100–150 percent of the Reserve Adequacy (RA) metric are considered adequate.

The augmented RA metric adds a buffer to account for the possibility of lower than projected oil prices.

Sources: Iraq authorities; and Fund staff estimates and projections.

Reserves within 100–150 percent of the Reserve Adequacy (RA) metric are considered adequate.

The augmented RA metric adds a buffer to account for the possibility of lower than projected oil prices.

3. Staff believes that the non-regression-based Investment Needs model is the most appropriate model for assessing Iraq’s CA at this juncture. Staff explored three different approaches for estimating a CA norm against which to assess Iraq’s projected CA balance:

  • The Investment Needs model(see Box 1), which proposes that resource-rich developing countries with scarce capital stocks and high investment needs should use part of their resource wealth to finance investment. CA norms derived with this model tend to be lower than those of other approaches but are highly sensitive to the calibration of investment inefficiencies, which reduce optimal investment levels and therefore increase the norm. In the case of Iraq, investment needs are significant, but inefficiencies are also assessed to be severe.
  • The Consumption Allocation model, another non-regression based approach, assumes that exhaustible resource exporters should smooth the consumption of resource revenues in order to satisfy inter-generational equity considerations. While this may gain relevance for Iraq in the longer-term, staff believe it is not appropriate for shaping immediate or medium-term policies given the ample energy reserves and significant investment needs.
  • Finally, the EBA-lite CA model, a regression-based approach, which does not fully account for the characteristics of oil-exporters, resulting in high residuals and a poor fit for such countries.2

4. The Investment Needs model indicates that Iraq’s CA in 2018 was stronger than warranted by fundamentals and desirable policy settings. The Investment Needs and EBA-lite CA models deliver cyclically-adjusted norms well below Iraq’s projected cyclically-adjusted CA balance of 5¾ percent of GDP in 2018, while the Consumption Allocation model provides a higher norm. Staff focuses on the Investment Needs model, which yields a CA norm of -4½ percent of GDP, implying a CA gap of 10 percent. The CA gap can be entirely explained by the fiscal balance in 2018, estimated to be a surplus of 8 percent of GDP, and the implicit “fiscal gap”, which can be obtained by comparing the 2018 fiscal balance to the medium-term fiscal objective: a debt-stabilizing overall balance of 2½ percent of GDP. The 2018 fiscal surplus, in turn, is largely due to higher oil prices. As a cross-check, and given the sensitivity of Iraq’s current account and fiscal balances to highly volatile oil prices, staff also estimated an “underlying” current account series, holding oil prices constant at a long-run average (Figure 3). As expected, the results of the underlying series would greatly reduce the CA gap in 2018.3 Based on the CA gap, staff estimates the REER to be about 20 percent undervalued in 2018. While standard policy advice in the context of a stronger than warranted CA might be to loosen policies, policymakers in Iraq face multiple objectives and the binding constraints lie in the areas of reserve adequacy and debt sustainability. Moreover, based on current projections, the CA gap is expected to close and reverse in 2019 and beyond with a significant worsening of the CA.

Figure 2.Iraq: Social Indicators, 2000–50

Sources: Worldwide Governance Indicators; Human Development Indicators; UN World Population Prospects (2017); and IMF staff calculations.

Figure 3.Iraq: Recent Economic Developments, 2013–19

Sources: Iraqi authorities; and IMF staff estimates and calculations.

Figure 4.Iraq: Fiscal and Debt, 2013–18

Sources: Iraqi authorities; World Economic Outlook; and IMF staff calculations.

Current Account Norm, 2018(In percent of GDP)
EBA-lite CAInvestment NeedsConsumption Allocation
Current account (CA) results
CA projection 1/2/5.75.75.7
CA norm 1/-1.9-4.57.1
CA gap7.610.2-1.4
Source: IMF staff estimates.

Cyclically-adjusted.

Cyclical adjustment is -1.2 percent of GDP.

Source: IMF staff estimates.

Cyclically-adjusted.

Cyclical adjustment is -1.2 percent of GDP.

Current Account: Actual versus Underlying

(In percent of GDP)

1/ Setting WEO and Iraqi oil prices to 1999–2018 average of US$60 and US$56.

Sources: Iraqi authorities; and IMF staff calculations and projections.

5. The Iraqi dinar peg with the U.S. dollar remains an appropriate nominal anchor for macroeconomic policies. The misalignment of the REER is expected to over-correct and move into slightly overvalued territory in 2019 as the CA weakens against its norm. Fiscal adjustment will be crucial to bring the CA back into line with fundamentals, preserve reserves, and ensure external stability over the medium term. In the longer-run, structural policies to improve competitiveness and achieve export diversification would also help support Iraq’s external position.

Box 1.The Investment Needs Model for Natural Resource-Rich Developing Countries

Countries that are rich in exhaustible natural resources experience windfalls that can be consumed, saved or invested—with each of these options having a disparate impact on macroeconomic outcomes and external stability. Empirical studies indicate that most resource-rich developing and advanced countries save much of their windfalls in an attempt to smooth consumption and ensure intergenerational equity, in line with the permanent income hypothesis (Friedman, 1957), and therefore tend to run current account surpluses.1

However, drawing on a separate stream of development thinking,2 Araujo and others (2013) question whether resource-rich developing countries (RRDCs) with large investment needs and external borrowing constraints should save as much as their advanced economy peers, or instead use these windfalls for investment in much needed physical and human capital. They develop a neoclassical small open economy model that aims at assessing the optimal external balance and savings/investment decisions in response to windfalls in RRDCs. The model explicitly incorporates the role of investment given capital scarcity in these countries but also captures pervasive frictions in RRDCs, such as investment inefficiencies, absorptive capacity constraints, and external borrowing constraints. Investment inefficiencies are modeled as impediments that prevent a dollar of investment translating into a dollar of productive capital, thereby lowering the optimal level of investment. Absorptive capacity constraints are adjustment costs that arise when the speed of investment negatively impacts project selection, management and execution, thereby necessitating a slower pace of investment. Finally, imperfect capital mobility and borrowing constraints are modeled through a country risk premium that can be relaxed as natural resource endowments lower the premium.

The results of the model suggest that the optimal external balance and savings/investment decisions for windfalls in RRDCs depend heavily on the degree of investment frictions. Facing borrowing constraints, but absent investment frictions, the model indicates that RRDCs should mostly convert windfalls into private and public capital rather than save them in the form of foreign assets. This would imply lower current account balances or even deficits. Furthermore, if resource wealth reduces RRDCs’ risk premia thereby relaxing their borrowing constraint, this can facilitate further private and public investment, implying still lower current account balances. However, the presence of investment inefficiencies and absorptive capacity constraints in RRDCs modulates these results, making it optimal to delay or decelerate capital accumulation depending on the degree of the frictions, implying higher current account balances than otherwise would be the case.

On the whole, the model delivers optimal current account balances and savings levels for RRDCs that are significantly lower than those implied by conventional approaches such as the permanent income hypothesis, but the extent of these varies depending on the presence and severity of investment frictions.

1 See Berns and Carvalho (2009) and Bayoumi and Thomas (2009).2 See Collier and others (2010) and van der Ploeg and Venables (2011).
Annex IV. Public and External Debt Sustainability Analysis

Iraq’s public debt will rise steadily over the medium term, reaching 56 percent of GDP, in tandem with widening fiscal deficits. Staff assesses that Iraq does not face major solvency risks, notwithstanding its limited debt carrying capacity. However, liquidity risks are high with financing needs consistently exceeding the high-risk threshold over the medium term, reflecting sizable amortization of external debt and short-term debt rollover. Public debt is subject to significant risks and particularly sensitive to adverse real growth and real interest rate shocks. A mitigating factor is that about a third of domestic debt comprises short-term debt held by the central bank.1

Public Debt Sustainability Analysis

1. Public debt is projected to increase in the medium-term from 49 percent of GDP in 2018 to 56 percent in 2024.2 Following a period of fiscal consolidation under the SBA that helped reduce public debt in 2017–18, Iraq’s overall fiscal position is projected to deteriorate over the medium term, shifting from a surplus of 7.9 percent of GDP in 2018 to deficits approaching 6 percent by 2024. This reflects lower oil revenue—oil prices are projected to be about $10 lower in 2019–24 on average than the 2018 level—and rising government expenditure by close to 10 percent annually on average over the medium term. The government has limited fiscal buffers (ID 20 trillion as of end 2018) to cover the rising deficits (the aggregate sum of deficits over the medium term is ID 80 trillion). Staff assumes that the government will use about ID 15 trillion of this buffer, with the remainder financed through borrowing. There are arrears on the order of ID 2.3 trillion (less than 1 percent of GDP), which have arisen partly for technical reasons, comprising ID 1.3 trillion arrears to an Iranian SOE for electricity and gas purchases, and around ID 1 trillion to International Oil Companies. As a result, public debt is projected to increase in nominal terms by over ID 67 trillion (or 52 percent) over 2019–24. The 32 percent growth in nominal GDP will mitigate the impact of the large increase in nominal debt on the debt-to-GDP ratio over the medium term.

Total Public Debt-to-GDP, 2017–24

(In percent of GDP)

Source: IMF staff calculations.

2. Guarantees and other contingent liabilities are significant. Debt and service guarantees, mostly in the electricity sector, were estimated to exceed 20 percent of GDP in 2017.3 There are also contingent liabilities in the banking sector relating to potential recapitalization of the two largest public banks, which cannot be accurately measured prior to an international audit.

3. A significant part of Iraq’s debt comprises legacy arrears that have yet to be restructured. The full face value of $40 billion of external arrears to non-Paris club creditors accumulated before 2003 is included in the stock of external debt, as they have yet to be settled in line with the 2004 Paris Club agreement terms.4 The DSA also maintains the conservative assumption that these arrears will not be settled during the projection period. If they were to be restructured on Paris Club terms, the debt-to-GDP ratio would fall from 51 to 37 percent of GDP in 2019, and from 56 to 46 percent in 2024

4. Gross financing needs (GFN) will increase significantly, and remain above the high-risk threshold over the medium term. The GFN is projected to rise sharply, remaining substantially above the high-risk threshold of 15 percent of GDP over 2019–24. Financing needs are rising due to widening deficits and a shift in the structure of debt toward shorter maturities, mostly T-bills either purchased by state-owned banks and discounted at the Central Bank of Iraq or purchased and retained by banks. At the same time, the longer maturity debt (mostly external) is declining as sizable external principal payments fall due starting 2019 (reaching over ID 8 trillion in 2024).

Gross Financing Needs (GFN), 2019–24

(In percent of GDP)

Source: IMF staff calculations.

5. The compositional shift towards domestic and short-term debt will continue over the medium term. Domestic borrowing will rise over the medium-term, mostly through the issuance of T-bills to banks either directly or through triangular operations at the central bank. On external debt, staff assumes Iraq will continue to rely on medium-to long-term external financing, but net external borrowing is projected to be negative given large amortization payments. As a result, domestic debt rises from 37 percent of total debt in 2018 to 56 percent of total debt by 2024. The share of short-term debt will also increase, especially for the new debt of which the share of T-bills will increase from 22 percent in 2018 to close to 60 percent by 2024.

6. The large financing needs coupled with an elevated level of public debt will constrain options to rebuild the country and address difficult social conditions, underscoring the need for fiscal adjustment. Post-conflict reconstruction and recovery needs are estimated at $88 billion, a small fraction of which is covered in expenditure over the medium term given current oil revenue projections. To ramp up capital spending significantly without endangering debt sustainability, the authorities would need to better control current spending and raise additional non-oil revenue. The government should also aim at building fiscal buffers to avoid excessive recourse to domestic and external borrowing if the oil price declines. Staff proposed adjustment path would help reduce debt to below 50 percent and financing needs to 15.7 percent of GDP (main document, ¶21).

7. Stress tests confirm that Iraq’s total debt is particularly vulnerable to growth and real interest rate shocks.

  • Growth shock: If projected real GDP rates are lowered by one standard deviation (implying lower real growth by 5.6 percentage points) in 2020 and 2021, the debt ratio would jump by 16 percentage points by 2021, and increase gradually to 77 percent of GDP by 2024.
  • Primary balance shock: This scenario assumes a worsening of the primary balance by 3.8 percentage points of GDP in 2020 and 2021. The larger deficit would lead to higher debt which will reach 65 percent of GDP by 2024.
  • Real interest rate shock: A one-time, permanent real interest rate increase of 10 percentage points in 2019 would make the debt ratio reach 73 percent of GDP in 2024.5
  • Real exchange rate shock: A one-time real depreciation of 30 percent in 2018 would increase total public debt to 65 percent of GDP by 2024.
  • Combined shock: A combination of these shocks would increase debt to 103 percent of GDP by 2024.

Figure 1.Iraq: Public Debt Composition, 2018–24

Source: IMF staff estimates and calculations.

Figure 1.Iraq: Public Debt Sustainability Analysis—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Source: IMF staff calculations.

1/ Public sector is defined as central government and includes public guarantees, defined as Public debt guarantee .

2/ Based on available data.

3/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

4/ Derived as [r- π(1+g) – g + ae(1+r)]/(1+g+π+gπ) times previous period debt ratio, with r = effective nominal interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

5/ The real interest rate contribution is derived from the numerator in footnote 5 as r-π(1+g)and the real growth contribution as -g.

6/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

7/ Other flows consist of drawdown of government deposits in the banking system.

8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 2.Iraq: Public Debt Sustainability Analysis—Composition of Public Debt and Alternative Scenarios

Source: IMF staff calculations.

Figure 3.Iraq: Public Sector Debt Sustainability Analysis (DSA)—Stress Tests

Source: IMF staff calculations.

Figure 4.Iraq: Public Sector Debt Sustainability Analysis(DSA)—Risk Assessment

Source: IMF staff calculations.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baselin red if benchmark is exceeded under baseline, white if stress test is not relevant

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but no baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ EMBIG (bp), an average over the last 3 months, 27-Oct-18 through 25-Jan-19.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure 5.Iraq: Public Debt Sustainability Analysis—Realism of Baseline Assumptions

Source : IMF staff calculations.

1/ Plotted distribution includes all countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for Iraq, as it meets neither the positive output gap criterion nor the private credit growth criterion.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Table 1.Iraq: External Debt Sustainability Framework, 2015–24(In percent of GDP; unless otherwise indicated)
Projections
20142015201620172018201920202021202220232024
Debt-stabilizing non-interest current account 6/
Baseline: External debt24.837.237.135.630.632.231.530.528.426.824.9-5.5
Change in external debt-0.512.4-0.1-1.5-5.01.6-0.7-1.0-2.2-1.6-1.9
Identified external debt-creating flows (4+8+9)-4.312.97.8-6.6-11.93.32.12.53.03.84.6
Current account deficit, excluding interest payments-2.96.27.9-2.2-7.34.73.73.74.04.85.5
Deficit in balance of goods and services-4.46.17.8-2.4-8.03.32.12.83.64.15.0
Exports41.335.332.138.144.040.139.537.736.435.334.3
Imports36.941.440.035.736.043.441.640.540.039.439.2
Net non-debt creating capital inflows (negative)-1.7-1.6-1.0-0.9-0.4-0.5-0.6-1.0-0.9-0.9-0.8
Automatic debt dynamics 1/0.38.20.9-3.4-4.1-0.9-1.1-0.3-0.2-0.1-0.1
Contribution from nominal interest rate0.30.30.30.40.40.50.50.50.50.50.5
Contribution from real GDP growth-0.2-0.8-5.70.80.2-1.4-1.6-0.8-0.7-0.6-0.5
Contribution from price and exchange rate changes 2/0.28.86.3-4.7-4.7
Residual, incl. change in gross foreign assets (2–3) 3/3.8-0.5-7.95.16.9-1.7-2.7-3.5-5.1-5.4-6.5
External debt-to-exports ratio (in percent)59.9105.3115.493.369.680.379.881.078.076.072.6
Gross external financing need (in billions of US dollars) 4/-4.513.015.4-2.4-14.014.014.316.420.121.224.9
in percent of GDP-1.97.38.8-1.210-Year10-Year-6.26.25.96.47.57.58.4
Scenario with key variables at their historical averages 5/30.623.818.613.16.40.00.0-1.3
Key Macroeconomic Assumptions Underlying BaselineHistorical AverageStandard Deviation
Real GDP growth (in percent)0.72.515.2-2.55.45.9-0.64.65.32.62.32.12.1
GDP deflator in US dollars (change in percent)-0.7-26.1-14.414.51.516.815.4-4.52.32.62.83.13.3
Nominal external interest rate (in percent)1.00.90.91.30.90.41.41.61.81.81.81.81.8
Growth of exports (US dollar terms, in percent)4.3-35.3-10.332.48.730.232.5-8.96.20.31.51.92.6
Growth of imports (US dollar terms, in percent)2.5-15.1-5.0-0.36.114.615.720.53.42.43.73.75.1
Current account balance, excluding interest payments2.9-6.2-7.92.20.77.17.3-4.7-3.7-3.7-4.0-4.8-5.5
Net non-debt creating capital inflows1.71.61.00.91.30.60.40.50.61.00.90.90.8
Sources: IMF; country desk data; and staff estimates.

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Sources: IMF; country desk data; and staff estimates.

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 6.Iraq: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Source: IMF; country desk data; and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-halfstandard deviation shocks Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debtdynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2019.

Annex V. Risk Assessment Matrix1

(Potential Deviations from Baseline)

Source of RisksLikelihood/ Time HorizonExpected Impact on EconomyPolicy Measures to Dampen the Impact of Shocks
Potential External Shocks
Large swings in oil prices. Uncertainty surrounding supply and demand shocks translates into elevated price volatility.Medium

Short to Medium Term
High. Iraq’s heavy reliance on oil implies that even modest price swings would undermine growth (via reduced public spending) or erode fiscal sustainability (higher deficits, or accumulation of arrears), and also put pressure on CBI reserves leading to increased vulnerabilities. Price volatility also complicates economic management, and adversely affects investment in the energy sector.Build fiscal space, diversify revenue away from oil, and improve the composition and efficiency of public spending.

Diversify the economy, encourage the emergence of the private sector and develop human capital.
Spillovers from geopolitical tensions.

The reimposition of U.S. sanctions on Iran could adversely affect Iraq in light of significant economic links through energy (electricity and gas), trade and tourism.
High

Short to Medium Term
High. Increased geopolitical tensions could undermine growth through confidence effects, as well as financial and energy channels. Vulnerabilities in the financial sector arising from ML/TF risks are subject to greater scrutiny, implying increased risks to correspondent banking relationships (CBRs). Iraq’s access to U.S. dollar funding could also be affected. If waivers on U.S. sanctions were not renewed, Iraq could face difficulties in sourcing and paying for electricity and gas imports, with a sharp adverse impact on domestic electricity supply.Financial Sector. Continue implementing AML/CFT measures to avoid gray-listing and negative impact on CBR. Energy. Existing initiatives to diversify energy sources, in particular by better exploiting domestic gas resources, would help lower Iraq’s vulnerability to disruptions in energy imports.
Sharp tightening of global financial conditions. Tighter financial conditions could be triggered by a sharper-than-expected increase in interest rates or other risks.Medium

Short to Medium Term
Medium. Notwithstanding Iraq’s limited exposure to global markets, tighter global conditions would exert upward pressure on debt service and risk premia, and could make it harder for Iraq to tap international financial markets (issuing new debt or rolling-over existing liabilities).

It could also lead to a tightening of domestic monetary conditions, given the U.S. dollar peg, with some impact on growth.
Implement fiscal consolidation to maintain debt sustainability.
Potential Domestic Shocks
Political instability and rising popular discontent amid poor policy implementation and political fragmentation.

Social dissatisfaction, related to weak public services, lack of job opportunities and high perception of corruption, is already elevated.
High

Short to Medium Term
High. Political stability would be undermined by a resumption of popular protests or a spike in internal tensions (intra and inter-communal). Such events would hinder the implementation of structural reforms, and compel the government to realign spending away from longer-term priorities towards items that buy social peace.Reach a consensus on the priorities and scope of reforms. Secure resources for capital spending and reconstruction (fiscal space) through fiscal consolidation. Implement Public Financial Management and other governance-linked reforms and tighten anti-corruption measures.
Resurgence of terrorism.Low

Short Term
High. A renewed conflict with ISIS or other terrorist groups could threaten Iraq’s stability, result in further severe damage to infrastructure, undermine country risk perceptions, weaken the business environment and discourage foreign investment.Build fiscal space to enable a reallocation of spending (including higher military spending if needed) while maintaining debt sustainability.
Annex VI. Governance

Context

1. Iraq suffers from widespread governance weaknesses, with significant risks of corruption:

  • Fiscal. There are tangible weaknesses in public financial management—including control of the public wage bill, public investment management, procurement and overall expenditure transparency—as well as in revenue and customs administration, and the governance and oversight of SOEs, which heighten vulnerability to corruption.
  • Legal/institutional. Weaknesses, particularly regarding enforcement of the rule of law and transparency, likely present obstacles to private sector development. Anti-corruption institutions have been established, and would need to be strengthened together with anti-corruption legislation in order to become more effective. Steps have been taken to strengthen AML/CFT (reflected in Iraq’s removal from FATF monitoring in 2018) but stronger implementation of the AML/CFT regime is needed to support governance efforts and preserve the integrity and stability of the financial sector.
  • Regulatory and business environment. Iraq ranked 171 out of 190 countries in the World Bank’s 2019 Doing Business Report, with weaknesses across the board and particularly acute problems in the areas of getting credit, trading across borders, resolving insolvency and starting businesses.
  • Corruption. Iraq scores poorly relative to the MENA average in both the Worldwide Governance Indicators (WGI) and Transparency International’s corruption perceptions index (Figure 1). Respondents to the World Bank’s Enterprise Survey also reported widespread bribery.

Figure 1.Iraq: Corruption and Governance Indicators, 2007–17

Sources: Transparency International; Worldwide Governance Indicators; and World Bank Enterprise Survey, 2011.

Note: There are uncertainties around point estimates from Transparency International and the Worldwide Governance Indicators. Scores are normalized and measure relative performance.

2. These weaknesses, in turn, undermine macroeconomic outcomes through a number of channels. Bribery and weak regulatory and legal institutions hamper private investment, while weak fiscal institutions lead to leakages and can reduce the effectiveness of public investment. Addressing such weaknesses would promote better macroeconomic outcomes through fewer fiscal leakages and increased investment (see main document, Box 1).

3. This remainder of this annex assesses public financial management, anti-corruption policies and AML/CFT, and provides recommendations in each area.

Public Financial Management

4. In recent years Iraq’s public financial management framework has performed poorly in terms of helping ensure fiscal discipline, strategic allocation of resources, and efficient service delivery. A weak legal framework has enabled spending to be approved through legislation outside the budget, while the absence of commitment controls allowed the emergence of arrears when revenues collapsed.

A. The Legal Framework

5. Parliament adopted a new General Financial Management Law (GFML) in May 2019 that strengthens the legal framework for public financial management.1 The law defines general government for the first time, establishes the need for a medium-term fiscal framework and enshrines fiscal transparency requirements. It also limits parliament’s capacity to amend the budget, and the scope for legislation approving spending to occur outside budget processes. Newly introduced elements of fiscal federalism could erode non-oil revenue.

Recommendations

6. The new law has left a number of gaps that need to be addressed by secondary legislation or decrees. These are required in particular with regards to the control and management of guarantees, commitment controls, and in-budget adjustments. Moreover, the authorities should develop an implementation plan for the new law.

B. Arrears and Commitment Controls

7. The emergence of arrears in 2015–16 underscored the consequences of weak commitment controls. Then, as now, the country lacked legal and procedural frameworks to limit spending units’ authority to enter into and execute commitments. There were also no rules establishing liability for assuming commitments without government approval based on the budget law. The absence of a commitment control system (CCS) implies insufficient reconciliation to prevent expenditures from being committed in excess of available financial resources. This could result in line ministries executing their entire annual original budget allocation, which the MOF will subsequently not be able to cover due to insufficient revenues.

8. Multi-year commitments present a particularly difficult problem since they should be viewed as mandatory expenditures, constraining the government’s capacity to assume discretionary or new mandatory commitments. In the absence of reliable information on existing commitments, and in light of possible ministerial and other decisions creating commitments without regard to the approved budget law, such constraints are difficult to incorporate into the budgeting process.

Recommendations

9. Implementation of a commitment control system would support effective budget execution. A comprehensive CCS would facilitate the necessary reconciliation between the approved budget, the available cash resources, and the actions of the SUs to achieve their objectives. Earlier FAD and METAC missions have provided extensive TA on implementing a simple CCS with adequate reporting that could be further enhanced when IFMIS is implemented. Such improvements would strengthen expenditure control with the goal of avoiding arrears.

C. Cash Management

10. The lack of centralized cash management makes it hard to assess the budget’s financing needs and thus complicate public debt management. Spending units manage their accounts at state-owned banks without centrally controlling their spending, and also regularly carries over balances between fiscal years and rationalize both their spending and calls for budget allocations. Savings therefore accrue to spending units rather than the budget, and if poor financial management results in arrears, they are eventually covered by the budget. Such weaknesses in controls erode central government’s capacity to manage fiscal resources.

11. These practices obscure the monitoring of budget execution. What appear to be seasonal patterns of underspending and overspending, respectively, in the first and second half of the fiscal year simply reflect that spending units often rely on accumulated “reserves” before calling their budget appropriations. Thus, while the MOF knows what the SUs are supposed spend their allocations on, it has limited information or effective control over actual execution.

Recommendations

12. These weaknesses could be best rectified by fully establishing a treasury single account that would release funds against spending items sanctioned by law. This will require significant institutional changes, including the restructuring of the two dominant public banks. In the interim, the authorities could establish a system of regularly swiping SU balances, and require spending units to request financing in line with legally or contractually verified obligations. This would increase transparency and strengthen the finance ministry’s control over resources.

D. Anti-Corruption

13. Iraq has over time established legal and institutional frameworks to combat corruption. The country is a party to the United Nations Convention against Corruption (UNCAC) and the League of Arab States Convention on Commercial Arbitration. A Commission on Integrity (COI) was set up in 2011 with the task of corruption prevention and enforcement, including investigating corruption cases, proposing legislation, and overseeing financial disclosures. In 2019, the Prime Minister established a High Council for Combatting Corruption, which along with the Parliamentary Integrity Committee, has the task of developing national policies and strategies to tackle corruption.

14. In the context of this framework, a number of public bodies are involved in combatting corruption, albeit with overlapping functions that can create inefficiencies and potential gaps. The bodies involved, apart from the COI, include the Offices of the Inspectors General (IGOs), the BSA and the Ministry of Planning. Despite similar mandates, limited coordination has led to redundancies in some functions (e.g., audits of the same body or project by multiple agencies) and gaps in others.2

15. Organizational bottlenecks and lack of capacity impede enforcement against corruption offences. Although the COI has investigated several high-profile cases, prosecution and conviction rates seem low relative to the risks faced by the country. One contributing factor is that all corruption investigations need to be channeled through an investigative judge, of which there are only two in Baghdad and one in each province.

16. Moreover, the linkages between corruption and money laundering are not reflected in enforcement activities. Although corruption is recognized as a significant source of illicit flows— particularly in vulnerable sector such as real estate—the authorities do not seem to be actively pursuing proceeds of corruption, with limited co-ordination between authorities responsible for AML/CFT and those detecting and investigating corruption. Likewise, national committees shaping policies for AML/CFT and anti-corruption do not appear to co-operate.

17. Iraq has had an asset disclosure system for public officials in place since 2011, which has yet to be used effectively to support prevention or enforcement efforts. Only around 10 staff in the COI with limited resources are tasked with verifying approximately 25,000 asset declarations submitted manually. Further, a failure to file entails an administrative penalty for which Ministers and Parliamentarians enjoy immunity, and filing rates among certain categories of public officials are low.3 Asset declarations have neither been published nor made available to relevant public authorities. As a result, the disclosure regime has neither been useful in facilitating the detection or investigation of corruption or financial crime, nor effective in supporting AML/CFT compliance.

18. Legal provisions granting amnesty may foster a culture of impunity. The General Amnesty Law allows officials who repays embezzled funds to be freed from culpability, and over 1,000 officials were granted amnesty in the first quarter of 2018 through this route. The funds repaid by officials receiving amnesty have generally fallen far short of the amounts involved.

Recommendations

19. Improvements to the legal framework would facilitate anti-corruption efforts. The Penal Code should be amended to criminalize illicit enrichment, trading in influence, embezzlement, and all forms of bribery. The legal framework also needs to be aligned with international norms on asset disclosures, access to information, conflicts of interest, and protection of whistleblowers and witnesses. Public officials convicted of corruption should be prohibited from holding office. Finally, the General Amnesty Law should be amended so it no longer applies to corruption offences.

20. The High Council and the Parliamentary Integrity Committee should co-ordinate to promote coherent anti-corruption laws and policies. Developing a shared understanding of corruption risks at the national level would help guide mitigating strategies and policies. The High Council should coordinate with parliamentarians to ensure that legislation reflects national priorities, and its membership should be expanded to include all stakeholders along the enforcement chain. Anti-corruption policies should be aligned with AML/CFT priorities.

21. Likewise, the institutional structure for combatting corruption needs to be streamlined and clarified. Agencies should coordinate to avoid duplication of tasks, and to improve accountability.

22. The asset declaration regime can be enhanced. The focus should be narrowed to the range of public officials most at risk of corruption and sufficient resources should be dedicated to digitalizing and verifying asset declarations. Information in asset declarations should be shared with relevant authorities. Clear penalties should be established and enforced for failure to submit declarations. Over time, asset declaration requirements could be extended to family members and the declarations themselves could be published.

23. The governance and autonomy of the COI and IGO should be strengthened. Priorities include strengthening the COI’s operational and financial autonomy, clarifying eligibility criteria for staff appointments (e.g., disqualification for past corruption offences), and establishing clear rules for staff dismissal, as well as legal protections for COI officials. Such safeguards should be instituted before the COI’s investigative powers are strengthened. The COI should also devote adequate resources to areas particularly vulnerable to corruption (e.g., extractive industry, procurement, verification of financial disclosures). Similarly, giving IGOs greater independence from their line ministries would help ensure that corruption cases are pursued.

24. E-governance efforts should be continued to simplify government procedures and limit opportunities for discretion. Digitalizing registries and databases (such as for property and real estate transactions) would improve access to information and facilitate cooperation among relevant authorities. Digitalization would also facilitate the detection of corruption and financial crime.

25. Building on recent progress, there is also scope for greater transparency on oil and gas sector contracts. The Ministry of Oil (MoO) has developed a policy on the disclosure of oil and gas contracts, which remains to be implemented pending the adoption of the law on access to information.

E. AML/CFT

26. Iraq has strengthened its AML/CFT regime since the Middle East and North Africa Financial Action Task Force (MENAFATF) assessment in 2012.4 A new AML/CFT Law, adopted in 2015, brought the legal framework into line with international standards, and established a national AML/CFT Council as well as the AML Bureau, the country’s financial intelligence unit. The Central Bank of Iraq (CBI) has issued instructions to banks on customer due diligence, including a risk-based approach and measures for higher risk customers, such as politically exposed persons (PEPs). The Council of Ministers also established procedures to freeze terrorist assets in line with United Nations Security Council resolutions. The FATF recognized these steps by removing Iraq from its list of jurisdictions with strategic deficiencies in 2018.

27. The country nevertheless remains exposed to significant money laundering and terrorist financing (ML/TF) risks. The economy is primarily cash-based, and a large share of financial transactions occur through unlicensed exchange houses or other informal channels. The proceeds of domestic corruption and terrorist-related flows pose significant vulnerabilities, including via cash smuggling. There are risks of shell companies linked to unlicensed exchange operators attempting to obtain dollars at FX auctions. Individual agencies are aware of these risks to varying degrees, and the authorities are beginning work on a national assessment of ML/TF risks.

28. Enforcement of money laundering offences and confiscation of criminal proceeds remains weak. Few cases have been disseminated by the AML Bureau for investigation. Prosecution and convictions are rarely secured, and the tracing and confiscating criminal proceeds is not actively pursued.

29. Gaps in supervision coupled with poor controls by banks have also created opportunities for financial crime. Some 15 staff in CBI’s supervisory departments are responsible for supervising over 70 banks and 2,000 licensed exchange houses, while the supervision of securities and insurance from an AML/CFT perspective has yet to begin. Moreover, a lack of oversight over the real estate sector makes it particularly attractive for laundering the proceeds of corruption.

30. Financial institutions generally do not appear to be taking a risk-based approach in their internal control systems. As was the case at the time of the 2012 FATF assessment, Iraqi banks seem to be applying AML/CFT measures primarily on a rules-based approach. Reporting of suspicious transactions by banks remains low, with no reports so far relating to PEPs or real estate transactions.

31. Cross-border cash transfers can also pose ML/TF risks. Any movements in cash exceeding $10,000 must by law be declared, and the customs service has been instructed to treat amounts exceeding $20,000 as suspicious, report them to the AML Bureau, and, if necessary, seize suspicious amounts. However, funds can be seized only at a few checkpoints, and with strict limits on how long they can be held.

Recommendations

32. There is considerable scope for AML/CFT measures to complement efforts to combat corruption. The authorities need to develop national AML/CFT priorities and risk mitigation strategies, based on a national assessment of ML/TF risks. AML/CFT tools should be systematically leveraged to identify and recover proceeds of corruption. Preventive measures, such as those requiring enhanced due diligence for PEPs and identification of beneficial owners, combined with transaction monitoring and customer due diligence, can help detect proceeds of corruption.

33. Greater cooperation and information sharing would help the authorities focus AML/CFT measures on tackling the proceeds of corruption. Information is decentralized, with few databases in electronic form or linked together, resulting in significant delays in the transmission of and access to information. This is a key impediment to effective detection and enforcement of money laundering and corruption offences. Law enforcement, the AML Bureau, and the CBI should therefore strengthen and formalize inter-agency cooperation, while the AML Bureau and the COI should coordinate more frequently.

34. Building on progress so far, efforts to strengthen supervisory capacity should continue. The CBI is piloting a risk-based supervision model with a view to full implementation in 2020, with rollout first to banks and subsequently to other financial institutions. Towards this end, the CBI needs to develop ML/TF risk profiles for banks and conduct AML/CFT inspections based on its risk-profiling. It should also finalize specific criteria that will be used to risk-profile banks and implement its new on-site procedures. These procedures should focus on assessing the risk understanding of reporting entities, the implementation of preventive measures (particularly relating to customer due diligence), and the reporting of suspicious transactions. Supervisors should remind banks of the importance of verifying beneficial ownership of companies seeking to obtain FX through auctions. These steps will have significant resource implications for the CBI.

35. Targeted efforts to reduce the size of the informal financial sector would help lower vulnerabilities to illicit flows. This would entail bringing entities acting in the informal sector into the regulatory fold (i.e., licensed and supervised) or shutting them down, including through more effective enforcement actions against non-compliant entities.

36. The governance and operational capabilities of the AML Bureau should be strengthened. The AML Law describes its mandate, powers, and responsibilities, but does not detail governance and reporting lines, or the process for selecting and dismissing staff, which could be clarified by a Council of Ministers decision. The Bureau’s resources also need to be enhanced.

37. Systems should be put in place to monitor the transportation of cash and bearer negotiable instruments. Developing an inter-agency network comprising the Customs Authority, the CBI, and the AML Bureau would help coordinate such efforts.

Annex VII. International Experience with Public Wage Bill Management

1. The public sector is the largest employer in Iraq with a rising wage bill, reaching 17.4 percent of GDP and accounting for over a third of central government budget in 2019. That would place Iraq among the top ten countries worldwide in terms of the size of the public-sector wage bill. Multiple factors have driven the increase including political pressure to find jobs for the large number of young people entering the labor market, facilitated by weaknesses in public financial management and a lack of centralized control.

2. International experience suggests that effective management of the wage spending requires fiscal planning, strengthening institutions, and structural reforms to accompany short-term consolidation efforts. A study of 20 country-experiences in wage bill rationalization demonstrates that short-term wage and employment measures can provide temporary fiscal relief.1 However, structural and institutional reforms that focus on improving the management processes in wages and employment have had long standing and sustained impacts, although they are more difficult to implement. Among compensation and employment measures, most countries have relied on across-the-board wage freezes and attrition-based employment reductions while a smaller group of countries have implemented structural measures such as reforming compensation, targeted employment reductions, public sector restructuring or steps to strengthen payroll management.

Short- and Long-Term Wage and Employment Policy Options for Iraq
Wage measuresEmployment measures
Short-term measuresAd hoc wage adjustment, e.g., wage freeze, capping allowancesAttrition-based employment reduction and elimination of vacant positions
Structural measuresStreamlining bonuses and allowancesTargeted employment reduction, e.g., separation incentives/packages
Structural pay policy reform, e.g., introducing performance related payPublic sector restructuring, e.g., functional workforce review
Strengthening payroll management, e.g., eliminating ghost workers, centralizing HR management and technological solutions

3. Ad-hoc measures, such as wage and employment freezes or temporary caps on allowances, can deliver short-term gains. The Iraqi authorities implemented such short-term measures under the SBA, which have either provided only temporary relief or have been reversed. This is line with international experience that while such measures could be effective in the near term, they tend to unravel over the medium term and adversely affect service delivery if not accompanied by appropriate structural reforms.

4. Structural compensation and employment measures are therefore essential to deliver long-term savings. On the compensation front, allowances should be streamlined, a unified wage scale should be adopted, and once administrative capacity is strengthened, wages should be better aligned with job requirements and performance levels. In addition, the public sector wage premium should be reviewed to ensure that public sector is not creating skill shortages in the private sector. On the employment side, public sector employment could be reduced through separations or targeted retirements.

5. Institutional reforms would support the effectiveness and sustainability of such structural reforms. Payroll management should be strengthened by conducting a census of government employees, centralizing human resource management, and identifying ghost workers and double-dippers. Furthermore, technological solutions such as installation of biometric systems, and a functional workforce review followed by possible downsizing or mergers of government units based on their functions, could deliver efficiency gains.

6. Given low capacity, wage bill management and civil service reforms should become centralized under the Ministry of Finance or another central authority. As Iraq develops higher capacity and improves governance systems, such delegations could be made to the line ministries and agencies under a set of standards guided by the central government. Until then, a central human resource management unit should champion the reforms and make decisions on hiring, promotion, and termination rules. In addition, enhancing data availability on government wages and employment, and flow of information between the central government and the Kurdistan Regional Government are crucial to undertake a comprehensive assessment and monitoring of the wage bill and public employment processes.

1Prime Minister Adil Abdul-Mahdi has compared the impact of corruption on Iraqi society to that of the ISIS terrorist group (http://www.rudaw.net/arabic/middleeast/iraq/3112201812).
2See Iraq: Reconstruction and Investment.
3Despite ample oil reserves, electricity supply has averaged only 17 hours per day in recent years, which is a key weakness of the business environment.
4Around a third of electricity supply comes either directly from Iran, or from Iraqi plants reliant on Iranian gas.
5The law was drafted with support from FAD TA, and its approval by government was a structural benchmark at the First Review of the SBA.
6In mid-May, peak electricity production was around 25 percent higher than a year earlier as new generating capacity has come onstream.
7See Macroeconomic Policy Frameworks for Resource Rich Developing Countries (IMF, 2012) and Current Account Norms in Natural Resource Rich and Capital Scarce Economies (Araujo and others, 2013).
8Looking much further ahead, once the capital stock has been rebuilt and inter-generational equity considerations grow in importance, fiscal policy can be anchored on long-term considerations and Iraq would be expected to run current account surpluses to accumulate assets for future generations, in line with the permanent income hypothesis (PIH).
9See accompanying Selected Issues Paper, “A Risk and Rules-based Approach to Fiscal Policy.”
10Donors pledged around $30 billion to support the reconstruction of Iraq at a donors’ conference in Kuwait in February 2018 organized by the World Bank. Disbursements seem to have been limited so far—with external project financing from all sources totaling less than $1 billion in 2018. Factors behind the delays include the time taken to form a government after the May 2018 parliamentary election, as well as the documentation requirements and project procedures established by donors.
11A number of provisions are exerting pressure on the wage bill in a context of weak PFM controls. Allowing certain ministries to convert contractual workers into full-time staff (e.g. Ministry of Electricity) and offer wage increases (e.g. Ministry of Health), has sparked demands from other ministries for similar treatment. The cabinet has allowed ministries to convert daily wage earners into contractuals. Recruitment of those dismissed on political grounds or due to security concerns, families of martyrs, and those returning from the liberated areas, and wage increases to doctors, nurses, and engineers have exerted further upward pressure on wage spending.
12Reforms to improve the reliability of electricity supply could lead to a substantial reduction in the effective price paid by Iraqi households by lessening their need for expensive back-up supplies. (see https://www.iea.org/publications/iraqenergyoutlook/)
13International experience suggests that it could take two to three years for the systems to be fully operational. In light of the work already done, the Iraqi authorities consider that the systems could be fully operational in 2020.
14See the Selected Issues Paper ‘Iraq: Financial Development and Inclusion’.
1The NEER saw a larger appreciation of 8V4 percent in 2018, in line with its sharper five-year trend (29 percent appreciation). The appreciation of the NEER over this period, including a spike in September 2018, largely reflects depreciations of the currencies of Iraq’s key trading partners against the U.S. dollar, to which the Iraqi dinar is pegged.
2The volatility of oil prices also makes it difficult to estimate the cyclical component.
3The underlying CA in 2018 is estimated at 1.2 percent of GDP, suggesting a CA gap of 5¾ percent of GDP against the Investment Needs norm of -4.5 percent of GDP.
1The main assumptions underpinning the DSA are presented in the lower panel of Figure 1 and are based on staffs medium-term macroeconomic framework.
2Applying an 80 percent haircut to the $40 billion of non-Paris Club arrears (comparable to the Paris Club treatment) would reduce headline public debt from 49 percent of GDP in 2018 to 34 percent of GDP.
3In 2017, the Debt Directorate of the Ministry of Finance completed a survey of guarantees issued by the central government. At end-June 2017, the stock of guarantees related to foreign currency service payments and debt amounted to $21.7 billion (12 percent of GDP) comprising $19.4 billion for service payments to independent power producers (IPPs) and $2.3 billion for debt.
489.75 percent reduction of the net present value (NPV) of the legacy arrears.
5The DSA methodology for generating interest rate shocks is based on GDP deflators rather than CPI inflation. As this standard approach implies an excessively large shock in the case of Iraq, due to the large weight of oil prices in the GDP deflator, we consider a moderate 10 percent real rate shock.
1Based on the Global Risk Assessment Matrix (February 2019). The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within one year and three years, respectively.
1The law was drafted with support from FAD TA, and its approval by government was a structural benchmark at the First Review of the SBA.
2For instance, COI does not conduct investigations in the oil and gas sector, which it considers falls under the purview of the IGO.
3In 2018, only around 17 percent of Parliamentarians, 59 percent of Ministers, 20 percent of governors, and 47 percent of provincial leaders had submitted asset declarations.
4See Mutual Evaluation Report of Iraq, FATF (November 2012).
1See Managing Government Compensation and Employment – Institutions, Policies, and Reform Challenges (IMF. 2016)

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